Turnaround of Sears Holdings - Turnaround Management Association

Turnaround of Sears Holdings
Naveen Jindal School of Management
The University of Texas at Dallas
Advisor: Professor David Springate
Author: Chris Clark
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TABLE OF CONTENTS
Executive Summary .......................................................................................................................................................................... 5
Department Store Industry Overview ............................................................................................................................................... 6
Products ....................................................................................................................................................................................... 6
Market Segments ......................................................................................................................................................................... 7
Industry Trends ............................................................................................................................................................................ 7
Key Industry Drivers ..................................................................................................................................................................... 9
Industry Challenges ...................................................................................................................................................................... 9
Industry Policy & Regulation ...................................................................................................................................................... 10
Industry Finance......................................................................................................................................................................... 11
Overview of Sears Holdings Company ............................................................................................................................................ 12
Sears Domestic........................................................................................................................................................................... 12
Sears Canada .............................................................................................................................................................................. 12
Kmart ......................................................................................................................................................................................... 13
History of Sears .......................................................................................................................................................................... 14
Sears & Kmart Merger ........................................................................................................................................................... 15
Recent Transformational Events ................................................................................................................................................ 16
SWOT Analysis ................................................................................................................................................................................ 18
Strengths .................................................................................................................................................................................... 18
Weaknesses ............................................................................................................................................................................... 19
Opportunities ............................................................................................................................................................................. 19
Threats ....................................................................................................................................................................................... 20
Operational Analysis ....................................................................................................................................................................... 21
Management and Corporate Governance ................................................................................................................................. 21
Non-Management Employees ................................................................................................................................................... 22
Comparison with Competitors ................................................................................................................................................... 23
Financial Analysis ............................................................................................................................................................................ 26
Historical Stock Price Performance ............................................................................................................................................ 26
Revenue Analysis ....................................................................................................................................................................... 29
Profitability and Margin Analysis ............................................................................................................................................... 32
Liquidity Analysis........................................................................................................................................................................ 33
Inventory .................................................................................................................................................................................... 33
Cash Burn Analysis ..................................................................................................................................................................... 34
Leverage Analysis ....................................................................................................................................................................... 35
Fixed Asset Analysis ................................................................................................................................................................... 35
Restructuring Alternatives .............................................................................................................................................................. 37
Maintain Status Quo .................................................................................................................................................................. 37
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Liquidation ................................................................................................................................................................................. 37
Strategic Buyer ........................................................................................................................................................................... 39
Breakup Analysis ........................................................................................................................................................................ 42
Recommended Plan ................................................................................................................................................................... 43
Increase Liquidity .................................................................................................................................................................. 44
Changes to Hardlines ............................................................................................................................................................ 45
Apparel .................................................................................................................................................................................. 46
Renovate Stores .................................................................................................................................................................... 49
Improve Customer Service .................................................................................................................................................... 49
Improve Margins ................................................................................................................................................................... 49
Management ......................................................................................................................................................................... 50
Valuation of the Plan ............................................................................................................................................................. 50
Appendix ......................................................................................................................................................................................... 54
Exhibit 1. Historical Financial Statements .................................................................................................................................. 54
Exhibit 2. Key Executives ............................................................................................................................................................ 57
Exhibit 3. Executive Compensation ............................................................................................................................................ 59
Exhibit 4. Relative Measures of Executive Compensation ......................................................................................................... 59
Exhibit 5. Comparison of Revenue with Selected Competitors .................................................................................................. 60
Exhibit 6. Change in Revenue from 2010 to 2011 ...................................................................................................................... 62
Exhibit 7. Historical Profitability Ratios for Holdings .................................................................................................................. 62
Exhibit 8. Comparison of Profitability with Selected Competitors ............................................................................................. 62
Exhibit 9. Comparison of Capital Expenditures to Depreciation for Selected Competitors ....................................................... 63
Exhibit 10. Relative Valuation of Kmart as a Standalone Entity ................................................................................................. 64
Exhibit 11. Relative Valuation of Sears Domestic as a Standalone Entity .................................................................................. 64
Exhibit 12. Relative Valuation of Sears Canada as a Standalone Entity ..................................................................................... 64
Exhibit 13. Calculations and Assumptions Used in Restructuring Plan ...................................................................................... 64
Exhibit 14. Valuation of Forever 21 ............................................................................................................................................ 65
Exhibit 15. Valuation of Holdings to Tesco ................................................................................................................................. 66
Exhibit 16. Valuation of Proposed Restructuring Plan ............................................................................................................... 67
Exhibit 17. Capital Expenditures of Proposed Restructuring Plan .............................................................................................. 67
Exhibit 18. Long Term Debt of Proposed Restructuring Plan ..................................................................................................... 67
Exhibit 19. Revenue Assumptions of Proposed Restructuring Plan ........................................................................................... 68
Exhibit 20. Pro Form Statement of Income for Proposed Restructuring Plan ............................................................................ 69
Exhibit 21. Pro Form Balance Sheet for Proposed Restructuring Plan ....................................................................................... 70
Exhibit 22. Pro Forma Statement of Cash Flows ........................................................................................................................ 71
Exhibit 23. Changes in Working Capital for Proposed Restructuring Plan ................................................................................. 72
Exhibit 24. Discounted Cash Flow Valuation for Proposed Restructuring Plan .......................................................................... 72
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Exhibit 25. Discounted Cash Flow Valuation in Upside Case ...................................................................................................... 73
Exhibit 26. Discounted Cash Flow Valuation in Downside Case ................................................................................................. 74
Exhibit 27. Estimated Earnings Per Share in Base Case .............................................................................................................. 74
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EXECUTIVE SUMMARY
Sears Holdings (“Holdings”) is a broad-line retailer that sells apparel, tools, consumer electronics,
appliances, sporting equipment, general goods and groceries through 4,010 stores in a variety of
formats located in the U.S. and Canada, 1,299 of which are independently owned and operated.
Holdings itself is only 8 years old, having been formed when Sears, the storied 125 year old retailer that
was once the largest in the U.S., merged its operations with that of Kmart, a similarly long lived retailer
and household name. Despite their longevity, Sears and Kmart have seen their sales and performance
deteriorate for the past 5 years amid the highly competitive retail environment and difficult economy.
Over the last two years, even as the economy improved and its competitors’ sales and profits rose,
Holdings’ have fallen, the result of deteriorating stores and poor merchandising. For the fiscal year
ending January 31st, 2012, Holdings posted a loss of $3.1 billion on sales of $41.6 billion, and had free
cash flow of negative $1.4 billion, despite a $587 million increase in unfunded pension liabilities and
capital expenditures that were $421 million less than depreciation. Despite Holdings apparent
difficulties, management has said very little of its plans to reverse the slide.
We examined the competitive landscape of the U.S. retail industry and analyzed its current trends and
challenges. We then examined Holdings operational and financial state to determine the causes of its
problems and potential opportunities available to it. Using this analysis, we assessed the feasibility and
value to shareholders of these alternatives and developed a comprehensive turnaround plan that we
believe will improve operations and set the company on a path for sustainable growth. The major
themes of this plan include:

Invest in the brand by renovating stores, improving customer service, and recruiting the best
leadership

Realign merchandise with the values of the brand and the store formats it operates

Reduce costs and improve gross margin
Despite its recent performance, Holdings is still an asset rich company, and we show that by capitalizing
on the assets in its portfolio, the proposed changes in our plan are economically viable.
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DEPARTMENT STORE INDUSTRY OVERVIEW
Holdings operates in the department store industry, retailing a broad range of appliances, tools, apparel,
sporting goods, house wares, and other consumer goods. The department store industry is distinct from
but in competition with a number of other retail focused sub industries, including:

Warehouse clubs and Supercenters such as Costco, Sam’s club, Wal-Mart Supercenters, and
Kmart supercenters (part of Holdings)

Category killers and specialty stores operating in a variety of industries such as Best Buy, Home
Depot, and Academy

E-commerce websites including Amazon and Buy.com
Dominated by nation-wide chains and large format stores that typically employ more than 50 people,
the industry brings in approximately $200bn in annual revenue and generates profits of around $7.4bn.
With a 20.3% market share, Holdings is the third largest player in this highly concentrated industry; the 4
largest firms, Wal-Mart, Target, Holdings, and Macy’s, account for 76.6% of total revenue.
Over the last 5 years, industry revenues have declined at an estimated annual rate of 3.1%, a trend that
is expected to soften as the economy improves, but not reverse.
PRODUCTS
The department store industry is divided into two groups. Discount department stores attempt to
attract thrifty shoppers while their up market counterparts target those with more disposable income.
However, both groups retail a similar set of merchandise.
It is estimated that apparel will generate 42.7% of the industry’s revenue for 2012. Women’s apparel
accounts for almost half of the category with 21.1% of total revenue, while men’s (10.2%) and children’s
(11.4%) account for the rest. Men’s and women’s apparel revenues have remained stable, but children’s
has increased from its 2007 level of 7.5%, representing the increasing popularity of fashionable
children’s clothing. Men’s, women’s, and children’s footwear account for 4.7% of revenues.
The drugs and cosmetics category, which includes prescription and nonprescription drugs, vitamins,
supplements, makeup, perfumes, soaps, and personal hygiene products, is estimated to account for 16%
of total industry revenue. While demand in this category is extremely stable, specialized discount stores
and ecommerce have caused this segment to contract from its 2007 level of 17.9%.
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Furniture and household appliances have fallen from 18.5% of revenue in 2007 to 16% in 2012,
representing the decline in housing construction, while toys and hobbies have increased from 4.8% to
8% over the same period, driven by the increasing popularity of video games and the number of children
per household. Other products, ranging from jewelry to linens, account for 12.6% of revenues, down
from 16.3% in 2007.
MARKET SEGMENTS
The department store industry offers a diverse array of consumer focused products, and thus market
segments are often defined by age group. In general, department stores target consumers age 25 to 65
as they have the greatest demand for their goods and the highest disposable incomes.

Under 25 (20%)
Limited disposable income
Often shop at smaller niche stores

25 to 40 (35%)
Typically employed with disposable income
May have growing children which need merchandise

41 to 65 (30%)
Higher disposable incomes, tend to purchase higher end goods
Often shop for grandchildren

Over 66 (15%)
Reduced disposable income stream
Reduced need for department store goods
INDUSTRY TRENDS
Our analysis of the industry revealed the following current trends.
Going Bigger and Smaller
Operators that straddle multiple retailing sub industries are transitioning away from department stores
into larger supercenters as well as smaller urban-friendly formats. In the 4 years preceding 2010, WalMart’s general merchandise locations shrunk from 1,083 to 708 while its supercenters grew from 2,262
to 2,907. Between 2009 and 2010, Target adopted an expanded line of groceries at 440 stores. However,
in order to better reach urban markets where space and zoning make the supercenter format
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untenable, Target has begun launching its CityTarget locations and Wal-Mart has created its
Neighborhood Market, Walmart Express, and Walmart on Campus.
Targeting Younger Consumers with Fast Fashion
Many department stores are starting to focus on the under 25 age demographic. Macy’s teamed up with
Madonna and her daughter Lourdes to create a new fast fashion junior’s collection called Material Girl,
while JC Penny introduced its own fast fashion brand MNG by Mango. Even Holdings has launched
Land’s End Canvas that targets younger customers as well as the Kardashian Kollection, which is slightly
more upscale but still targeted at the 20-30 age demographic. Meanwhile, Kohl’s has created brands
around celebrities Jennifer Lopez and Marc Anthony, also intended to appeal to younger consumers.
Brick and Click Integration
Most retailers have had online stores for some time, but JC Penny, Macy’s, and Nordstrom have gone
even further by equipping their stores with POS system that support online orders, thereby enabling
sales associates to access a much broader assortment of merchandise. JC Penny and Kohl’s now have
self service kiosks that allow shoppers to place orders for out of stock merchandise. Kmart also launched
its “mygofer” service which allows customers to place orders online and have them bagged and ready
for pickup at a local store on the very same day.
Store Within a Store
Some retailers are turning to the “store within a store” concept to provide a more branded experience
for shoppers. JC Penny has opened “Sephora in JC Penny” locations within its existing stores staffed with
Sephora trained associated. Holdings, albeit perhaps for different reasons, has taken this concept a step
further by leasing space within its stores to fast fashion retailer Forever 21 and upscale grocery chain
Whole Foods Market.
Embracing Mobile Technology
While it may not yet have a noticeable impact on revenue, most of the major operators such as JC
Penny, Kohl’s, Kmart, Holdings, and Macy’s have tried to stay current by releasing their own mobile
applications that allow customers to browse weekly circulars, receive coupons, search for nearby stores,
create shopping lists, and even make purchases. Meanwhile, Nordstrom’s installed Wi-Fi access points in
all of its full line stores. Macy’s has even leveraged the availability of smart phones by placing QR codes
– 2D barcodes that can be scanned by smart phones to open a link or application - on some of its
merchandise that show the customers a short video clip from the designer.
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Social Commerce
Retailers continue to seek ways to leverage social media in commerce. Most retailers’ ecommerce sites
have a presence on – and integration with – social media sites like Facebook. Macy’s and target have
even signed a deal with Kickbucks, a location based social networking mobile application that rewards
customers for “checking in” at participating stores.
KEY INDUSTRY DRIVERS
Per capita disposable income
Sales in the retail industry are influenced heavily by consumers’ disposable income. Low disposable
incomes translate to reduced sales and a shift towards lower-cost substitutes. Per capita disposable
income is expected to increase in 2012, representing an opportunity for the industry.
External competition
Department stores compete with numerous other retail formats. E-commerce currently poses a
significant threat, as customers are beginning to grow accustomed to the selection, value, and
convenience that online retailers offer.
Consumer sentiment index
Consumer’s confidence in the economy and therefore their own financial well-being determine the
amount of disposable income they are willing to spend. As the economy improves in 2012, consumer
sentiment is expected to increase.
Unemployment rate
Given its connection with disposable income and consumer sentiment, the national unemployment rate
is a key driver of industry sales. This metric is expected to decline over the course of 2012.
Population growth
Because the retail market is largely saturated, the size of its market is influenced long term by the size of
the population. U.S. population growth will be slow in 2012, but positive.
INDUSTRY CHALLENGES
Retail has long been a highly competitive industry, and existing players currently face numerous
challenges.
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Operating the right formats
Store formats continue to evolve, and retailers must always be market led in order to stay competitive.
Wal-Mart and Target gained their market positions using off-mall discount department stores, and are
now transitioning to supercenter formats, while at the same time online retailers are seeing the largest
growth.
Inventory control
Apparel is seasonal and hardlines (electronics, tools, appliances, etc.), in particular consumer
electronics, become obsolete very quickly. Therefore it is crucial that retailers control their inventory
levels. Technology such as RFID has helped in this area, and predictive analytics for consumer buying
habits can further help retailers in stocking the right products.
Differentiation
Many retailers offer the same goods and services, and therefore must seek ways to differentiate
themselves from their competitors. Wal-Mart has seen enormous success by positioning itself as the low
price leader, while Target offers goods that are more stylish. Many also offer their own private label
brands, such as Holdings’ Kenmore and Craftsman. The retailer’s ability to craft a consistent brand image
and align its merchandise with this image is crucial to its success.
Seasonality
The retail industry is seasonal, with 32.1% of annual sales occurring between October and December.
Thus, stores must ensure they can maintain inventory levels during periods of higher demand.
Furthermore, many stores must temporarily increase headcount in these months.
As mentioned under the Industry Drivers section, retail sales are closely linked to the health of the
overall economy, and thus retailers must be prepared to respond to unexpected changes in the
economy. We believe this is a factor in the low amount of leverage used by the largest retailers.
INDUSTRY POLICY & REGULATION
The retail industry is largely regulated at the state level. Most of the legislation pertinent to retail
governs commerce in general, such as fair trade, credit, and antitrust laws and we do not foresee the
regulatory environment causing major disruptions in the near term.
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However, the majority of the goods retailers sell are produced internationally and therefore subject to
varying tariffs. The current global trend is towards free trade, and therefore we believe these tariffs will
slowly decrease. Nonetheless, tariffs for some merchandise such as footwear can be as high as 37.5%.
Historically, all states have levied sales and use taxes against goods and merchandise purchased within
the state. In-state merchants are responsible for collecting sales tax at the time of sale, but out-of-state
merchants are exempt from this requirement. If the out-of-state retailer elects not to collect the
appropriate sales and use taxes at the time of purchase, it is typically still the responsibility of the
purchaser to pay the sales or use tax, but most do not. This has meant that sales and use taxes for the
majority of online purchases have gone uncollected, giving online retailers an advantage over brick-andmortar retailers, but recent events indicate that advantage may soon begin to disappear. Amazon has
recently struck deals with several states to begin collecting sales tax as it desires to put warehouses in
these states, possibly indicating that Amazon feels the incentives it can seek from states and the
reduced shipping costs will outweigh the loss in sales. Amazon may also foresee the passage of national
legislation that will require it to begin collecting taxes in all states, and therefore desires to win
concessions from states for voluntarily collecting sales taxes while it still can. If passed, Senate Bill 1452,
titled the “Main Street Fairness Act”, would give states far more power to enforce out-of-state retailers
to collect sales taxes at the time of purchase. The net effect of this change in policy and legislation will
be advantageous to brick-and-mortar retailers including Holdings.
The movement towards environmentally friendly business practices has influenced participants in the
industry, with some retailers advertising their “green” initiatives such as reduced energy usage and
switching to sustainable products.
INDUSTRY FINANCE
Most of the largest retailers own their own stores and carry very little debt in their capital structure,
making the industry vary capital intensive. However, working capital needs for retailers that do not offer
their own credit cards are low, often about 5-10% of sales, as the largest retailers are able to procure
financing from their venders in the form of extended payment terms.
Sources: S&P NetAdvantage, IBIS World Report, Mergent Online
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OVERVIEW OF SEARS HOLDINGS COMPANY
Holdings operates as three divisions described below. Exhibit 1 provides historical financial statements.
SEARS DOMESTIC
Sears Domestic is the largest division of Holdings, with revenues of $21.6 billion. It operates a variety of
store formats, with its flagship locations being mostly on-mall department stores. The following outlines
the current formats Sears Domestic operates1:

Sears Full-line stores (834 locations) – primarily on mall stores averaging 95,000 sq. ft. in size,
these stores carry most of the categories of products Sears offers.

Sears Essentials/Grand (33 locations) – these stores are primarily rebranded and renovated
Kmart locations averaging 120,000 sq. ft. in size and retailing a similar mix of products.

Sears Home Appliance Showroom (75 locations) – these stores are typically off-mall and offer
Sears full range of appliances and are much smaller in size than other formats.

Sears Auto Center (37 locations) – offering profession automotive services.

Sears Hardware (96 locations) – these stores target more rural markets and offer Sears full
selection of tools and hardware.

Land’s End (14 locations) – apparel stores featuring Sears Land’s End brand.
Sears Domestic also operates 9 locations of The Great Indoors, an up-market home improvement and
appliance superstore. However, it plans to close all existing locations of this format in 2012. The Sears
Outlet stores (116 locations) retailed off-price surplus merchandise from its other stores, but these were
recently spun off, as were its Hometown stores (995 locations), which offer groceries and convenience
items.
SEARS CANADA
Sears Canada is the smallest of Holdings’ divisions, with current revenues of $4.6 billion. It is traded on
the Toronto Stock Exchange with 95% of its outstanding shares owned by Holdings. Its retail channels
include:

Sears Full-line stores (122 locations) – mall based department stores similar to those of Sears
Domestic which retail a broad range of merchandise, also focusing heavily on hardlines.
1
Source: Holdings’ 2011 10-K. While the annual report states that Sears Domestic has 1,338 specialty stores, the store totals it presents in the
same report add to 1319.
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
Sears Home stores (48 locations) – located in unenclosed retail parks, Home stores offer
furniture, mattresses, electronics, and appliances.

Hometown Dealer stores (285 locations) – independently owned and operated off-mall stores
that offer appliances, furniture, electronics, and outdoor power equipment.

Outlet stores (11 locations) – offer clearance merchandise from all channels, but particularly the
Catalog channel.

Appliance and Mattress Stores (4 locations) – offer only major appliances and mattresses.

Sears Home Services – in-home service and repair.

Corbeil (30 locations) – major appliance specialty stores.

Sears Floor Covering Stores (17 locations) – independently owned and operated stores offering
broadloom and hard floor covering.

Cantrex – a group of independent retailers that sell a broad range of products and services.

Sears Travel (108 locations) – Sears own brand of travel agencies.

Direct – catalogs with a distribution of 3.2 million, and online sales at Sears.ca which saw 81
million visits in 2011. Sears operates 1,700 pick-up locations where customers can receive their
orders.
Sears Canada’s retail channels differ from that of Sears Domestic. They are more diversified and have a
greater reliance on catalog based sales. Sears Canada’s operations are mostly separate from that of
Sears Domestic – it operates its own logistics, distribution, and transport facilities located in Canada, has
its own call center operations, and its own headquarters in Toronto, Ontario. In 2011, Sears Canada paid
Sears Holdings $4.7 in connection with shared purchasing arrangements. Given a cost of goods for 2011
of $2,923 million, this represents a negligible portion of their purchasing.
On May 17th, Holdings announced that it would reduce its ownership of Sears Canada from 95% to 51%.
Due to the timing of this event, its effects were not factored into our calculations in the Restructuring
Alternatives section.
KMART
Kmart is the second largest division of holdings and has current revenues of $15.3 billion. Kmart
competes directly with stores like Wal-Mart and Target. As of January 2012, Kmart operated 1,279
discount stores, and 26 Super Centers, which carry groceries and produce similar to Wal-Mart
Supercenters. Merchandise includes consumer electronics, seasonal items, outdoor merchandise,
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sporting goods, toys, lawn and garden, apparel, and groceries. Kmart also offers Sears’ proprietary
brands such as Kenmore, Craftsman, and DieHard, and 22 Kmart stores offer Sears Auto Centers. Of
Holdings 38 domestic warehouses, 23 primarily support Sears, 11 primarily support Kmart, and the
remaining 4 support both. Operations of Kmart and Sears Domestic are far more integrated than those
of Sears Canada. Besides sharing transportation and logistics, they also share a headquarters and
executive management team. Public filings state that $488 million in synergies were realized in the fiscal
year following the merger.
HISTORY OF SEARS
Richard Sears began retailing through a catalog first published in 1888, initially targeting rural customers
who had limited access to fairly priced goods. By 1893, sales had already exceeded $400,000. By 1894,
the catalog had grown to 322 pages and offered sewing machines, bicycles, sporting goods, and even
automobiles, in addition to numerous other items. Chicago clothing manufacturer Julius Rosenwald
joined the company in 1895 and began streamlining operations. Within a year, the catalog had
expanded to 532 pages and offered dolls, refrigerators, and groceries, and Sales grew past $750,000. In
1906, Sears opened a catalog production facility in a new building, the Sears Merchandise Building
Tower.
The company opened its first retail store in 1925 in the lower levels of its headquarters. The first
freestanding retail store opened later that year in Evansville, Indiana. Three more department stores
opened around Chicago in 1928. Sears continued to build new stores as well as buy out other
merchants, including Becker-Ryan, Holly Stores, Dunham Stores, and Schiller Millinery. Sears also
formed Homart, a mall development company, in 1959. By the 1980s, Sears was becoming a major
conglomerate. It entered the cafeteria business in by acquiring Furr’s Cafeteria, and three years later
acquired Bishop Buffets. It also acquired Dean Witter, a brokerage service, Caldwell Banker, a real estate
firm, and Pay Less Drug Stores. Sears also started Prodigy, an online service provider through a joint
venture with IBM in 1984, and Discover, a consumer credit card company in 1985.
Over the years, Sears created a number of its own exclusive brands of merchandise. Craftsman tools
began in 1927 and the line continues to be viewed as a high quality manufacturer of hand tools. Sears
also established the home appliance brand Kenmore in 1927, though it did not possess its own
manufacturing capabilities and instead rebranded other manufacturers’ products, a practice that
continues today. DieHard automotive batteries, also manufactured by a third party, have been offered
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since the 1960s. The three aforementioned brands are currently held by KCD IP, LLC, a special purpose
bankruptcy remote entity. Current brands also include Coldspot, Covington, and Evolv. Notable brands
such as Gold Bond, Allstate, Penske, National Tire and Battery, and many others were introduced by
Sears but later divested.
In the mid to late 80s and into the 90s, Sears began divesting many non-retail entities such as
restaurants, Discover Card, Dean Witter, Caldwell Banker, Homart, and many others.
Kmart’s history also began in the early 1900s. Sebastian S. Kresge founded the S.S. Kresge Company, a
“five and dime” retailer (offering merchandise for $.05 and $.10). The first Kmart store opened in 1963,
just months before the first Wal-Mart. The company quickly expanded. It, too, acquired numerous other
enterprises, including Borders and Walden books, book retailers, The Sports Authority, a chain of large
format sporting goods stores, Builders Square, a big box home improvement store, and OfficeMax, an
office supply store. However, during the 80s and into the 90s, many of Kmart’s stores were beginning to
look outdated, and many analysts accused management of focusing too heavily on the specialty store
formats. Kmart spun off its other store formats and began renovating its namesake stores in the early
90s. It even changed its corporate logo, however its high dividend combined with its failure to invest in
computer systems to manage its supply chain ultimately took their toll on the retailer, and it filed for
Chapter 11 bankruptcy in 2002. Investor Edward Lampert bought up enough of the company’s debt to
control the entity once it emerged from bankruptcy, and later went on to merge it with Sears.
Sources: searsarchive.com
SEARS & KMART MERGER
In 2004, Kmart and Sears agreed to merge. Both parties had motivations for the merger and identified
synergies that they believed would serve to increase shareholder values. Kmart was seeking a strategy
that would differentiate it from its competitors, and it felt that Sears’ strong brand image, proprietary
brands, and financial position would give it this differentiation. Sears was also looking to differentiate,
particularly by growing its presence in the off-mall multi-line retailers industry. The following are the
synergies identified at the time of the merger by both companies’ boards in a SEC filing:
1. Enhanced market position – the combined entity would see sales of $55 billion, making it the
second largest retailer in the US, and would have 3800 stores.
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2. Real estate – Sears’ prior agreement to purchase 54 of Kmart’s properties would be accelerated.
Duplicative properties could be sold.
3. Exclusive brands – Sears had brands such as Kenmore, Craftsman, and DieHard, while Kmart had
Martha Stewart, Sesame Street, and Route 66.
4. Cost reductions - $200 million in operating profit synergies, $200 million reduction in purchasing
costs, $100 million reduction in other costs.
5. Stronger management – each firm’s strengths would benefit the other.
Immediate financial results of the merger were mixed. Sears EPS declined from $11/share in 2004 to
$5.59 in 2005, with management citing the challenges of managing such a large enterprise. However,
according to public reports filed by Holdings, the firms were able to realize $488 in synergies to proforma EBITDA, in line with their pre-merger estimates.
Sources: company SEC filings
RECENT TRANSFORMATIONAL EVENTS
Over the past decade, Sears has experimented with a number of store formats to better compete with
the likes of Wal-Mart, Best Buy, and Home Depot. Various store formats included:

Supercenters and Hypermarkets – Sears Grands are off mall hypermarkets ranging from 165,000
to 225,000 sq. ft., while Essentials stores are renovated Kmart locations that offer Sears brand
merchandise. Only 33 Sears Grand/Essentials stores remain and 17 are slated for closure in
2012.

Specialty Stores – Sears Hardware stores offer Sears full lineup of hardware and are primarily
intended for more rural areas. Sears Appliance Showrooms average 8,500 sq. ft. and are located
away from malls. The Great Indoors were upscale home redecorating and remodeling stores
averaging 142,000 sq. ft. There are currently 96 Hardware and 75 Appliance Showroom stores.
All remaining Great Indoors stores will close in 2012.
Soon after taking control of Sears, Edward Lampert outlined his ideas on managing retail. He stated that
the industry norm of managing for same-store sales was a mistake and that retailers should instead
focus on profitability.
In 2008, Mr. Lampert ousted the current CEO Aylwin B. Lewis and announced a management
restructuring plan. Mr. Lampert claimed the current management structure was too centralized, and
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individual managers needed “greater control, authority, and autonomy.” To achieve this, the
restructuring plan called for the creation of the following 5 groups, each headed by its own president
with his or her own budget and priorities.

Brands, which would manage Sears intangible assets such as Kenmore, Craftsman, and DieHard

Real Estate, which would manage the company’s real property assets

Online, to manage Sears’ ecommerce initiatives

Operating Business Units, which would oversee apparel, appliances, consumer electronics, etc.

Support, which included marketing, IT, and finance
In order to show the degree of autonomy the divisions would have, it was even stated that the Brands
group would be free to license Sears’ brand assets to other retailers. Mr. Lampert also stated that his
plan was to achieve 10% EBITDA, and that same-store sales was not a focus, as it is with other retailers
in the industry.
In 2010, Sears announced that it would lease space inside some of its anchor stores to other retailers,
including fast fashion retailer Forever 21 and upscale grocery chain Whole Foods Market. In 2011, it
announced lease agreements with Western Athletic Clubs and Gonzalez Grocery, and has posted to its
website 4000 locations with retail space available to other merchants.
Sears had long been the exclusive retailer of its key private label brands, but in 2011, Sears announced
that it would begin selling its Craftsman line of tools through Costco, a nationwide warehouse club. Its
DieHard battery brand would also be sold through other retailers. The financial press currently reports
that Kenmore may soon be sold by other merchants as well.2
Sears has had an online retail presence for many years, but in July 2009, it revamped its online store by
launching the Sears.com marketplace, an ecommerce solution that allowed other merchants to sell
goods though its online store, similar to the Amazon Marketplace. Other online offerings include
MyGofer, an online purchase/in-store pickup service, and a failed movie download service called
Alphaline Entertainment.
In late 2009, Sears launched “Shop Your Way Rewards”, a customer rewards program that allows
shoppers to accumulate points on their purchases and redeem them for discounts on future purchases.
2
“Sears to License Names of Kenmore, Craftsman Brands”. The Wall Street Journal. April 4, 2012.
Page | 17
Sears continues to tout this program into 2012 as a primary transformational strategy, hoping the
program will build customer loyalty and give it great visibility into the shopping habits of its customers.
In late December 2011, Sears announced that it would close 120 of its Sears and Kmart discount stores,
citing a difficult economy and deteriorating sales. Same-stores sales for the eight weeks ended
Christmas Day, 2011, were down 4.4% overall, and 6% in the US Sears stores. These closing were in
addition to 10 store closings that were announced earlier in the year.
In January 2012, CIT, the largest U.S. provider of loans called “factoring” informed its customers that it
would no longer approve credit for new orders of merchandise for Sears.3 However, the financial press
later reported that it reversed this decision for unknown reasons. Goods factored by CIT account for less
that 5% of Sears inventory according to a statement made by Sears.
In February 2012, after incurring a $2.4 billion loss in its 4th quarter, Sears announced that it would take
steps to shore up capital. This included the sale of 11 stores to General Growth Properties for $270
million in cash and a plan to spin off its over 1,000 Sears Hometown and Outlet stores in a transaction
that was expected to generate $400 to $500 million. Sears also announced cost cutting measures and
reduced inventory by $544 million since the same period last year.4
SWOT ANALYSIS
STRENGTHS

Sears is still the third largest merchandise retail company in the US after Wal-Mart and Target.
Its large number of stores including prime on-mall premises and distribution centers provide an
advantage over smaller retailers.

Sears owns a number of trademarks and brand names with which consumers are familiar. In
addition to its namesake Sears brand, which has existed since 1912, its Kenmore, Craftsman,
DieHard, and Land’s End brands are widely known to consumers.

Excluding independently owned and operated locations, Sears Domestic owns 61% of its stores,
while Kmart owns 16% and Sears Canada 8%. This compares with: Dillard’s (80%), JC Penny
(30%), Macy’s (55%), Home Depot (89%), Target (86%), and Wal-Mart (87%). Sears can utilize
sale-leaseback agreements to unlock the capital stored in this real estate to effect a turnaround
3
4
“Lampert Fund Stepped In to Back Up Sears Lenders”. The Wall Street Journal. March 14, 2012.
Sears Holdings Earnings Conference Call, February 23, 2012.
Page | 18
plan if it must, but this may serve as a disadvantage in the long term, as many of its competitors
already own a greater percentage of their stores.

Sears continues to have undrawn credit facilities at its disposal in excess of $4.3 billion.
WEAKNESSES

The condition of many stores has gone neglected, as evidenced by journalists’ commentary and
10 years of capital expenditures far below depreciation. This has led to a poorer shopping
experience and given its competitors, whose capital expenditures have predominantly exceeded
depreciation, a strong advantage in attracting buyers’ dollars.

A core benefit of malls is the customers’ ability to comparison shop at multiple retailers very
quickly. Sears, however, derives 48% of its revenue from hardline goods that are not commonly
offered by other large mall retailers. Competitors with off mall locations even clump together in
certain markets – for instance, Home Depot locating close to Lowes, and Target close to WalMart – giving consumers an incentive to shop there instead of going to the mall.

Despite most of Holdings’ competitors seeing a rebound in revenues over the last two years as
the economy recovers, Holdings’ revenues have continued to decline, indicating that shoppers
are leaving the retailer for its competitors.

Holdings inventory turnover has declined over the last 5 years and is currently well below that of
retailers offering similar products. In addition to harming revenue, this represents an increased
risk that the retailer will have to discount older merchandise in order to move it off their
shelves.

Holdings has high turnover rates among management and non-management employees. NonCEO executive compensation appears to be significantly lower than that of the industry, possibly
representing a missed opportunity to attract top talent and a cause of the high management
turnover rates.

Revenue from the “services and other” segment lower than the industry average potentially
indicates a missed opportunity to sell extended service plans.

Negative Free Cash Flow in the most recent year has, and will continue, to limit its ability to
invest in turnaround initiatives.

Profitability is suffering; gross margin is lower and SG&A higher than many of its competitors.
OPPORTUNITIES
Page | 19

Many department stores are focusing more on the 18-30 year old demographic by offering fast
fashion apparel to compete with retailers like Forever 21. Private label brands such as the
Kardashian Kollection could attract younger shoppers and help Sears increase traffic and
introduce the brand to a demographic that does not currently have a reason to shop there.

While ecommerce revenues still make up a negligible percentage of Holdings’ sales, 2012
revenues grew by 16% from the year before. Its new Sears.com Marketplace competes directly
with Amazon’s, and will even house and ship seller’s merchandise – a service Amazon does not
provide. “Bricks and clicks” integration, allowing customers to shop and purchase online but
pickup in-store gives it another advantage over online-only retailers.

Holdings’ revenue per FTE (full time equivalent) is lower than that of its competitors, yet some
claim sales associates are less helpful and knowledgeable than those at other retailers,
potentially due to lower employee satisfaction and higher turnover. If Sears could invest more
heavily in its sales staff, it would improve customers’ shopping experience and be more
competitive.

Holdings’ “Shop Your Way Rewards” will increase customer loyalty and give the retailer better
insight into consumers buying behavior.
THREATS

Holdings’ faces a serious threat from ecommerce companies like Amazon, whose revenue
continues to increase year over year. While Sears does have its own ecommerce platform now
similar to that of Amazon’s, and even offers “bricks and clicks” integration that online-only
retailers lack, its online sales currently represent a negligible amount to total sales.

48% of Holdings’ sales come from hardline goods, including appliances, electronics, and tools.
Specialty retailers like Best Buy, Home Depot, and Lowes pose a significant threat in this
segment by offering convenient off-mall locations, broad selections, and knowledgeable
salespeople. This reliance on hardline goods may also make it more susceptible to declines in
home ownership and housing starts than other retailers.

Discount retailers such as Wal-Mart, Target, Sam’s club, and Costco offer competitive products
at lower prices.

Holdings’ namesake brands including Kenmore, Craftsman, and DieHard are seeing their market
position eroded by increased competition from LG, Electrolux, DeWalt, and Duracell, etc..
Page | 20

Some of Holdings’ vendors use a credit facility known as “factoring” to fund the manufacture of
goods. CIT, the largest provider of factoring in the US, announced that it would stop providing
factoring to Sears manufacturers in January 2012, but later reversed the decision. More
generally, as Holdings’ position continues to decline, it may face increasing difficulties
purchasing inventory on favorable terms.

Holdings has begun selling its private label brands, including Craftsman and DieHard, through
other retailers. Without this exclusivity, customers have fewer reasons to shop at Sears.

Employee morale seemed low during our visits to stores. Stores were unkempt and sales people
seemed to lack interest in making sales.
OPERATIONAL ANALYSIS
MANAGEMENT AND CORPORATE GOVERNANCE
Detailed biographies of key executives are provided in Exhibit 2.
Holdings’ management team possesses extensive experience in corporate governance and strategy, but
the current CEO lacks experience in the retail industry. Holdings has also seen significant turnover in its
management ranks over the last several years. Three CEOs have had the helm over the last 7 years:
Aylwin B. Lewis took the position in September 2005, but was ousted in favor of W. Bruce Johnson in
February 2008, who was in turn replaced by Louis J. D'Ambrosio in February 2011. Of the 8 executives
Holdings lists on its website, 2 have held their positions for less than four months, 4 have been around
for less than 18 months, and the remaining 2 will soon celebrate their 2 year anniversary. Lower ranks of
management have fared no better. Monica Woo left her post as Chief Marketing Officer only 5 months
after taking the position. Dev Mukherjee joined as President of the Home Appliances business in
November 2010 and left in March 2012. John Goodman, Executive Vice President since November 2009
left in January 2012.
In order to create an industry comparison, we averaged the reported compensation for executives of
Wal-Mart, Target, JC Penny, Macy’s, and Dillard’s. The following graphs depict Holdings CEO and other
executive compensation over revenue and number of employees compared to the average of its
competitors. While CEO compensation appears to be close to the industry average, other executive
compensation appears to be less than half the industry average, which could conceivably factor in
Holdings’ high management turnover. We also believe that Holdings’ below average capital
Page | 21
expenditures, which we explain in the Fixed Asset section, could weigh on management morale and
further increase turnover. Exhibits 3 and 4 provide further details.
Management’s publicly stated turnaround agenda does not give much attention to the biggest problems
facing Holdings, such as deteriorating store conditions, and instead focuses heavily on technology and its
online division, which, as we will show, currently generates too little revenue to be material to
operations. In his letter to shareholders dated February 23rd, 2012, Chairman Edward Lampert states
that “reinventing the company through technology” continues to “occupy most of my Sears-related
attention.” While technology and “brick and click” integration should certainly be part of the company’s
overall strategy, we believe there are more pressing matters for management to be consumed with, and
the Chairman’s letter neither gave specific examples of how Holdings would reduce costs, nor how it
would improve margins or reinvigorate sales.
NON-MANAGEMENT EMPLOYEES
Holdings’ employees are not unionized and most are paid an hourly wage or a base hourly wage with
commission. While data is scarce, hourly wages appear to be similar to its competitors. Sears has
continuously adjusted downward the commissions it pays to salespeople, which has served to increase
turnover and sour employee relations . The total number of full and part time employees as reported on
Sears annual report have been in steady decline over the past 7 years, from 312,000 in 2005 to 264,000
in 2011, mostly due to store closings. Revenue per employee is in line with Macy’s and Dillard’s but
behind that of Wal-Mart and Target.
Page | 22
COMPARISON WITH COMPETITORS
In order to better understand Holdings operations, we visited 3 Sears Domestic locations and 1 Kmart
location, as well as at least one location of Dillard’s, JC Penny, Macy’s, Best Buy, Home Depot, Wal-Mart,
and Target. All locations were visited on Saturdays on non-holiday weekends between 10AM and 4PM.
We present our findings below.
Sears Domestic

Foot traffic at all three stores was less than half that of its competitors at the same mall.

The condition of all three stores was poor. Floors were old and discolored, lighting was mostly
overhead fluorescent with very few spot lights or other special fixtures.

Electronics
The selection of electronics consisted primarily of mid-range, name brand flat screen TVs. At two
stores, the display for photo and video cameras were missing most of the display models.
Dangling wires from missing display models and sparse shelves made the department seem
under-stocked, making the selection appear worse than it actually was. In comparison, WalMart offered a bigger selection of TVs and a similarly sized selection of DVD and BluRay players,
but a much larger selection of portable consumer electronics and accessories. Best Buy’s
selection was larger in all areas. Prices on electronics seemed competitive with that of Best Buy,
but above those of Wal-Mart. In Best Buy, we were approached by a salesman after standing in
the TV section for only a few minutes. Sears salesman typically took significantly longer to
approach us.

Appliances
Sears’ selection of appliances was larger than that of Best Buy, Home Depot, and Wal-Mart, and
Page | 23
also offered a greater selection of price points and brands. The department also seemed better
staffed and better trafficked than others.

Tools
The selection of tools is mostly of the Craftsman and Evolv (Holdings’ lower end) brands. We
found the lack of selection and smaller overall size to be a serious disadvantage for Sears
compared to Home Depot. However, it did have a number of specialty items, including garage
floor coverings, garage storage and organization, that we found to be lacking at Home Depot.
The selection of toolboxes was also superior to that of Home Depot. While Sears does retail a
selection of lawn and garden supplies, it does not sell lumber, plumbing, and building supplies
found at Home Depot and Lowes.

Lawn and Garden
The lawn and garden selection focused on power tools including lawn mowers, most of the
Craftsman brand. Though the selection of lawnmowers seemed similar in size to that of Home
Depot, the lack of competing brands made the selection seem limited. Very few shoppers were
seen in this section.

Women’s Apparel
We believe the women’s apparel section occupied greater than 30% of the store area. The
selection seemed very outdated compared to that of other mall department stores, and had
almost no formal attire. The space was dominated by low height racks, and we estimated that
over 90% of them displayed sale tags. While this did give us the impression that we would find
good prices, it did not give us any hint as to where to begin looking. Other mall department
stores showed off merchandise by placing it higher on displays, and highlighted it using special
lighting. Prices seemed much lower than other mall competitors, while quality was slightly
lower. We felt quality was similar to that of Wal-Mart and Target, and prices were slightly lower.
Perhaps the biggest difference between Sears and its competitors was that it lacked the
prominent display of major brand names, other than Land’s End. There were also very few
accessories offered, though the selection of casual footwear seemed quite large.

Junior’s
The selection of apparel for young women seemed very sparse, though prices were low. Racks
seemed poorly organized and the styles were outdated compared with other mall department
stores.
Page | 24

Men’s Apparel
We believe the men’s apparel selection occupied about 20% of the total store area. The
selection was predominantly casual, and styles seemed to be similar to that of Wal-Mart and
Target, as well as the lower-end offerings of other on-mall department stores. Shelving was
better than that in the women’s section. Prices were far below those of its competitors,
sometimes by up to 60%, and we felt that quality was only slightly lower. As mentioned in the
women’s apparel section, the selection of casual footwear was quite competitive.

Automotive
Sears’ automotive selection was smaller than that of Wal-Mart, and focused mostly on
consumables and tires, whereas Wal-Mart offered a number of accessories and car electronics.
However, Sears appeared to offer more automotive services and repairs than Wal-Mart, giving it
an opportunity to sell more services to customers.

Sporting Goods
Sears offered a wide selection of home fitness equipment and other sporting goods – much
larger than that of other mall department stores and Wal-Mart and Target.

Children’s
The children’s selection seemed somewhat dated and poorly organized compared to that of
other department stores, though the selection of baby seats was larger. We found it peculiar
that the Children’s section in two locations was closer to the tools department than the
women’s department.

Furniture
The furniture department in all three stores was very small and not very visible. It offered
primarily lower priced contemporary furniture. Other department stores offered much larger
furniture selection with a wide variety of styles and price points.

Kitchenware
Sears’ selection of kitchenware was smaller than its competitors, though we felt the selection
for kitchen electrics, such as blenders and mixers, was competitive. Prices appeared to be
predominantly lower than competitors.
Kmart

The Kmart location we visited seemed far less trafficked than Wal-Mart and Target, but its rural
location could be partially to blame.
Page | 25

The overall condition of the store was poor. Shelves seemed old, and the checkout counters
seemed cluttered.

Apparel
The apparel selection at Kmart seemed smaller than that of Wal-Mart and Target, but the
recognizable brands such as Joe Boxer appeared to be an advantage. Prices seemed comparable
to other discount department stores, but the layout and shelving seemed poorer. The selection
of accessories also seemed sparse.

House wares
The selection of house wares such as linens, closet organization, vacuum cleaners, etc. seemed
poorly stocked and offered prices similar to that of Wal-Mart, but below those of Target. We felt
Target had a far more attractive collection of linens.

Toys
The toys department seemed mostly competitive with that of Target, but smaller and more
expensive than Wal-Mart’s.

Other Goods
In almost all other sections, the prices seemed high compared to both Wal-Mart and Target. The
merchandise also seemed older and the selections concentrated on the low-end. We also felt
the overall store layout made it difficult to find what we were looking for.
FINANCIAL ANALYSIS
HISTORICAL STOCK PRICE PERFORMANCE
In April 2007, Holdings’ stock price reached its all time high of $191.23, giving it a market capitalization
of $29.5 billion. As the economy worsened from 2007 through 2008, Sears share price continued to fall,
reaching a low of $30.44 in November 2008. The stock price rebounded with the economy until May
2010, when it saw a precipitous fall. Though it briefly regained some steam, Holdings’ stock price has
trended mostly downwards since then, reaching a low of $29.14 in January 2012. Holdings’ price was
lifted recently as the overall market gained traction, but has again begun to decline. As of April 24th, its
common stock was trading at $52.25 with a market capitalization of $5.56 billion.
Page | 26
SHLD Adjusted Share Price
$250.00
Share Prie
$200.00
$150.00
$100.00
$50.00
$0.00
4/24/2007
4/24/2008
4/24/2009
4/24/2010
4/24/2011
4/24/2012
The following chart depicts Holdings’ share price performance over the last 5 years with that of 8 of its
major competitors: Wal-mart (WMT), Target (TGT), JC Penny (JCP), Macy’s (M), Home Depot (HD),
Dillard’s (DDS), Best Buy (BBY), and Amazon (AMZN). Share prices were adjusted to account for splits
and dividends in order to give a better picture of total returns. Of the 9 competitors, Holdings fared the
worst, losing 69.8% of its value. Best Buy and JC Penny also performed poorly, declining 52% and 51%
respectively. All other competitors have gained in value, with Amazon taking the lead at 392%.
Page | 27
Adjusted Share Price Performance
Compared to Competitors
600.00%
500.00%
400.00%
AMZN, 391.8%
% Change
300.00%
200.00%
100.00%
0.00%
1/3/2007
-100.00%
1/3/2008
1/3/2009
1/3/2010
1/3/2011
DDS, 92.9%
HD, 47.4%
WMT, 36.2%
M, 13.4%
TGT, 7.7%
JCP, -50.6%
1/3/2012
BBY, -51.8%
SHLD, -69.8%
-200.00%
The following chart shows Sears share price performance compared to the S&P 500 as well as the S&P
Retail Index (RLX) over the last 5 years. While the retail index has outperformed the S&P by 18.2% in the
period, Holdings’ has underperformed the S&P by almost 67%.
Adjusted Share Price Performance
Compared to Indices
40.00%
20.00%
% Change
0.00%
-20.00%
-40.00%
SHLD
S&P 500
RLX
-60.00%
-80.00%
-100.00%
The following table lists relative valuation metrics for Holdings and a number of its competitors. The
ratios show that Holdings is generally valued lower than its competitors, a sign that investor confidence
is low. Price to earnings growth (PEG) is actually negative as earnings are expected to decline over the
Page | 28
next 5 years. Enterprise value over EBITDA is high relative to competitors, possibly due to investors
believing EBITDA will recover or because they are valuing the equity based on underlying assets. Analyst
opinions are similarly bearish, with only one firm issuing a positive recommendation for the stock.
PEG (5-Year Projected)
Price/Book
Sears
Dillard's
Target
Wal-mart
JC Penny
Macy's
Best Buy Home Depot
-0.36
2.19
1.24
1.44
1.28
0.98
1.29
1.23
1.3
1.56
2.43
2.83
1.96
2.84
1.76
4.45
EV/Revenue
0.21
0.61
0.8
0.56
0.56
0.84
0.17
1.25
EV/EBITDA
30.78
5.73
7.46
7.15
9.58
6.36
2.66
10.54
Firm
Standardized Opinion
EVA Dimensions
Sell
Ford Equity Research
Underperform
Ativo Research
Sell
Standard & Poor's Equity Research
Neutral
Thomas White International, Ltd.
Sell
Thomson Reuters/Verus
Sell
Columbine Capital Services Inc.
Underperform
Market Edge
Buy
Ned Davis Research
Neutral
GMI
Neutral
Zacks Investment Research, Inc
Underperform
REVENUE ANALYSIS
The charts in Exhibit 5 depict revenues by merchandise segment. Merchandise segments include:

Hardlines (49% of revenue)– consumer appliances, electronics, lawn and garden, tools, toys, and
sporting goods

Apparel and Soft Home (29% of revenue) – women’s, men’s, and children’s apparel, footwear,
jewelry and accessories

Food and Drug (14% of revenue) – grocery and pharmacy items

Services and Other (8% of revenue) – includes appliance maintenance and repair, automotive,
and extended service contract revenue
Exhibit 6 shows the equivalent revenue breakdown for each division of Holdings as well as the
department store industry. While hardlines comprise 49% of Holdings’ revenue, they make up only 24%
of its competitors. A stark difference is also seen with regards to apparel. While the industry as a whole
derives 48% of its revenue from this category, it makes up only 29% of Holdings’.
Page | 29
Each of Holding’s major divisions have seen a continuous decline in revenue over the last five years. The
only outlier to this trend was Sears Canada’s performance in FY2010, when it slightly exceeded FY2009
revenue. Sears Domestic, the largest reporting division accounting for 52% of overall sales in 2011, has
seen revenues fall from $27.8 billion in 2007 to
Revenue by Division
$21.6 billion in 2011, a decline of 22%. Over the
same period, Kmart, the second largest division
with 37% of overall revenues in 2011, saw sales
30,000
20,000
fall 11% from $17.2 to $15.3 billion, while Sears
Canada, which accounted for 11% of 2011
revenues, saw a decline of 15% from $5.6 to $4.6
10,000
0
billion. While it is not reported separately, results
2007
from online sales of both sears.com and
Sears Domestic
kmart.com were estimated based on information
2008
2009
2010
2011
Kmart
Sears Canada
contained in Sears 2011 annual report due its prominent role in management’s stated turnaround plans.
Revenues for the online division did increase by 16% from the prior year, but its contribution to overall
revenue is estimated to be less than $100 million and therefore negligible to Holdings’ overall
performance.
Although part of the revenue declines are attributable to the closing of unprofitable stores, all divisions
other than online saw a decline in same-store sales between FY2010 and FY2011, with Sears Canada
faring the worst with a decline of 2.9% in overall revenue and a 7.7% decline in same-store sales. Sears
Domestic operations saw a decline of 2.9% in overall revenue and a 3.4% decline in same-stores sales,
after adjusting to exclude the increase in sales from the online division. Kmart showed the least negative
results with a decline of 2% in revenue and 1.4% in same-store sales. Overall, Holdings saw a decline of
2.2% in same-store sales from 2010. Exhibits 5 and 6 provide further comparisons between Holdings and
its competitors.
As the economy has rebounded over the past 2 years, many of Holdings’ competitors have seen sales
begin to increase. However, Holdings’ sales continue to decline, although not as fast as they did in 2008
and 2009, when it saw declines of 7.8% and 7.3% respectively. In 2010, Holdings’ saw a decline of 1.6%,
while 2012 saw a sharper decline of 2.6%. These trends are depicted in the graph below, where
Holdings’ is seen as the lowest line in 2011.
Page | 30
150%
140%
130%
Sears
Dillards
120%
Target
Wal-mart
110%
JC Penny
100%
Macy's
Best Buy
90%
Home Depot
80%
70%
2007
2008
2009
2010
2011
The following charts depict Holdings’ revenue per square foot and FTE relative to its competitors.
Revenue per square foot for Kmart is far worse than its closest competitors, Wal-Mart and Target, and
Holdings’ overall revenue per FTE lags significantly behind many of its competitors.
Revenue per Sq. Ft.
Revenue per FTE
($ thousands)
($thousands)
300
$1,400
$1,200
$1,000
$800
$600
$400
$200
$-
250
200
150
100
Dillards
Kmart
Sears (overall)
JC Penny
Sears Domestic
Macy's
Sears Canada
Target
Home Depot
Wal-mart
Best Buy
50
0
Page | 31
PROFITABILITY AND MARGIN ANALYSIS
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%
Over the last 5 years, Holdings’ net income
has generally declined due to falling gross
margins and inability to reduce selling,
general, and administrative as quickly as
revenues have fallen. Gross margin has
generally trended downward, falling from
27.7% in 2007 to 25.5% in 2011, while SG&A
expenses as a percentage of sales have
2007
2008
2009
2010
2011
SG&A
22.6%
23.6%
24.2%
24.4%
25.7%
Gross Margin
27.7%
27.1%
27.7%
27.4%
25.5%
Operating Income
0.1%
0.1%
0.2%
0.2%
0.2%
Net Income
1.6%
0.1%
0.5%
0.3%
-7.6%
Adjusted EBITDA
4.8%
3.3%
4.0%
3.2%
0.7%
increased from 22.6% to 25.7%. EBITDA,
adjusted to exclude onetime charges and non-operating income, has also trended downward from 4.8%
in 2007 to 0.7% in 2011.
Of the 3 reporting divisions, Sears Domestic has delivered the worst performance with an operating
income of -6.7% of sales. Gross margin was 26.8% while SG&A came in at 27.9%, and actually increased
on a dollar basis from the prior year, mostly due to increased insurance costs and legacy pension plan
costs. Depreciation and write downs made up the rest of the loss. Sears Canada had a gross margin of
28.8%, SG&A of 27%, and an operating income of -0.4%. Kmart’s gross margin is lower than its sister
divisions (22.7%), but lower SG&A expense combined with depreciation of less than 1% of sales allowed
it to generate the least loss of -0.22%.
The table below compares Holdings’ profitability with that of select competitors. Holdings’ gross margin
of 25.5% lags behind most of its competitors, with the exceptions of Best Buy and Wal-Mart. Its other
competitors enjoy a much higher margin on their sales. We believe this is largely due to the discounts
Holdings must offer to incent sales. SG&A is below that of Dillard’s, JC Penny, and Macy’s, but as 27% of
revenues come from Kmart, which competes directly with Wal-mart and Target, and because of its focus
on appliances, electronics, and tools, which more closely compete with Best Buy and Home Depot, one
would expect SG&A to be lower. We believe Holdings’ SG&A expense as a percentage of revenue is
higher than normal due to revenues shrinking faster than overhead. Operating Income and Net Income
are significantly lower than its competitors, which causes return on assets and equity to fall short.
Exhibits 7 and 8 provide more information on Holdings’ performance relative to its competitors.
Page | 32
Sears
Dillard's
Target
Wal-mart
JC Penny
Macy's
Gross Margin Rate
25.5%
35.5%
30.9%
25.0%
36.0%
40.4%
25.1%
34.5%
SG&A % of Sales
25.7%
26.8%
20.2%
19.1%
29.6%
31.4%
20.5%
22.8%
0.2%
7.4%
7.6%
5.9%
0.0%
9.0%
4.2%
9.5%
Operating Income % of Sales
Net Income % of Sales
Best Buy Home Depot
-7.6%
7.4%
4.2%
3.5%
-0.9%
4.8%
2.5%
5.5%
ROA
-13.8%
10.7%
6.5%
8.4%
-1.3%
5.9%
7.1%
9.7%
ROE
-49.2%
22.5%
18.8%
22.5%
-3.2%
22.0%
19.8%
21.2%
LIQUIDITY ANALYSIS
Holdings’ liquidity has declined in the most recent year, primarily due to posting an operating loss, even
after adjusting for non-cash items. In February 2012, Holdings announced that it would increase liquidity
by selling stores and spinning off its Sears Hometown and Outlet stores. Together, this was expected to
generate $670 to $770 million.
2011
2010
2009
2008
2007
Quick Ratio
0.16
0.24
0.27
0.24
0.25
Current Ratio
1.11
1.34
1.3
1.34
1.34
Net Current Assets % Total Assets
4.83
12.02
10.69
11.46
11.83
6.1
5.8
5.4
6.5
5.4
34.3
36.0
38.3
32.2
34.7
Days Receivable
Days Payable
Holdings is generally less liquid than its competitors, even before its most recent year. Due to its recent
losses, cash reserves and therefore its quick and current ratios fell sharply, though its historic cash levels
are lower than all of its competitors, excluding Wal-Mart. It also seems to have less favorable terms with
its vendors, as its Days Payable is less than that of its competitors, thereby increasing working capital
needs.
Sears
Dillard's
Target
Quick Ratio
0.16
0.28
Current Ratio
1.11
1.83
Net Current Assets % Total Assets
4.83
5.9
34.3
Days Receivable
Days Payable
Wal-mart
JC Penny
Macy's
Best Buy Home Depot
0.54
0.2
0.54
0.51
0.4
0.34
1.15
0.88
1.84
1.4
1.21
1.55
16.75
4.64
-3.79
20.35
11.38
10.14
12.7
1.9
38.0
4.7
N/A
6.2
16.5
7.2
40.9
51.8
39.9
49.9
58.2
47.5
38.4
INVENTORY
Page | 33
Holdings’ inventory turnover has steady declined over the past 5 years from 3.7 to 3.5. This indicates
that inventory is sitting on shelves longer. Relative to other department stores, Holdings’ turnover
seems average, however, given that Kmart competes directly with Wal-Mart and Target, and the fact
that Holdings’ has a heavy reliance on hardlines, which compete with Best Buy and Home Depot, one
would expect inventory turnover to be higher.
Inventory Turnover
Inventory Turnover
2011
2010
2009
2008
2007
3.5
3.5
3.6
3.6
3.7
Sears
Dillard's
Target
Wal-mart
JC Penny
Macy's
3.53
3.12
6.23
8.7
3.6
3.19
Best Buy Home Depot
6.61
4.4
CASH BURN ANALYSIS
After adjusting for non-cash charges including restructuring charges and write downs, Holdings’ EBIT for
2011 was $(576) million. Depreciation totaled $853 million, while capital expenditures were only $360
million. Working capital decreased by $33 million, giving a Free Cash Flow (FCF) of $(1419) million.
Holdings has current liquidity of about $3.2 billion, including $747 million in cash, before the
transactions mentioned under Liquidity Analysis are executed and funded. Assuming the transactions
discussed under the Liquidity Analysis section close in the next few months and generate the estimated
$670 million in proceeds, and the company did not increase its borrowings beyond its current undrawn
letters of credit or see a change in FCF, Holdings would run out of cash after 31 months, or around
August 2014.
($ millions)
2007(A)
2008(A)
2009(A)
2010(A)
2011(A)
EBIT
1,410
543
818
485
-576
Tax Rate
37.9%
46.2%
29.3%
19.4%
-78.2%
Tax
(550)
(85)
(123)
(36)
(1,369)
1,049
981
926
900
853
Depreciation
Change in Net Working Capital
-287
-1
567
-534
-33
Capital Expenditures
-475
-411
-338
-406
-360
1,721
1,029
716
1,477
-1,419
FCF to Firm
On May 17th, 2012, Holdings reported 1Q 2012 results, which showed a GAAP income of $189 million.
However, it reported proceeds from the sale of property and investments of $446 million. Therefore,
the real income from continuing operations should be $(257) million, which represents a slight
improvement from FY2011.
Page | 34
LEVERAGE ANALYSIS
Though its loss in FY11 caused its interest coverage to decrease dramatically, Holdings continues to be
less levered than many of its competitors. However, Holding’s GAAP EBIT is negative, leading to a
negative interest coverage ratio.
Holdings
Interest Coverage
LTD/Equity
LTD as % of Invested Capital
Total Debt/Equity
Dillard's
Target
Wal-mart
JC Penny
Macy's
Best Buy Home Depot
-2.0
6.5
6.2
12.3
0.0
5.4
24.3
11.2
0.5
0.4
0.9
0.7
0.7
1.1
0.1
0.6
26.9
27.9
41.1
37.7
40.4
48.6
8.6
37.5
0.8
0.4
1.1
0.8
0.8
1.3
0.3
0.6
Most of Holdings’ debt is due after 2016. The following includes $455 million in capitalized lease
obligations.
Maturity Date
Amount ($millions)
2012
230
2013
70
2014
54
2015
150
2016
40
Thereafter
1,774
Total
2,318
FIXED ASSET ANALYSIS
Excluding independently owned and operated locations, Sears Domestic owns 61% of its stores, while
Kmart owns 16% and Sears Canada 8%. This compares with: Dillard’s (80%), JC Penny (30%), Macy’s
(55%), Home Depot (89%), Target (86%), and Wal-Mart (87%).
Exhibit 9 compares Holdings’ capital expenditures with that of its competitors. While its competitors’
expenditures exceed depreciation by 13.3%, Holdings has averaged -50.5% over the last 10 years. WalMart’s capital expenditures appear to be in line with Holdings’ but we believe this not a relevant
comparison due to Wal-Mart’s strategy of leaving old buildings (often smaller formats) and builder news
ones (often supercenters). Best Buy may also be a poor comparison as we believe the average age of its
builds to be less than that of Holdings. Holdings’ stores have thus suffered from a lack of investment,
and many now appear old and uninviting.
Page | 35
($ millions)
2011
2010
2009
2008
2007
2006
Owned Stores
2711
2811
2807
2857
2825
2817
PP&E
6,577
7,365
7,709
8,091
8,863
9,132
Depreciation
853
900
926
981
1,049
1,142
Capital Expenditures
Net Investment Over Dep. 1
432
441
361
497
570
513
-49.4%
-51.0%
-61.0%
-49.3%
-45.7%
-55.1%
(1) (Capex-Depreciation)/Depreciation
Page | 36
RESTRUCTURING ALTERNATIVES
MAINTAIN STATUS QUO
While revenues and profits over the last 5 years have continued to shrink, free cash flow stayed positive
until 2011. However, 2011 saw a negative free cash flow of $1,485 million. In order to remain a going
concern, Holdings will have to increase capital expenditures to match or exceed depreciation and cover
pension expenses related to actuarial gains or losses on its legacy defined benefit pension plan. Due to
Holdings’ pension holdings its own debt and stock, declines in the values of these assets could result in a
negative feedback effect, and if the total assets of the pension fund drop below 60% of the liabilities,
benefits must be reduced. Had capital expenditures matched depreciation in 2011, free cash flow would
have been further reduced to negative $1,912 million (see Exhibit 9 for historical depreciation and
capital expenditures). At this rate, Holdings will exhaust its existing liquidity after 23 months, or January
2014 (note that this is shorter than the runway given in the liquidity section due to the inclusion of
capital expenditures). Holdings’ may be able to extend this by reducing expenses and continuing to
shrink operations, thus freeing up working capital, but as its revenues, gross margins, and profitability
continue to decrease, even as its competitors are increasing theirs, it will eventually be forced to
restructure. Many options for restructuring available to it now will disappear as its condition
deteriorates, and the likelihood that Sears will be forced to negotiate with creditors or seek bankruptcy
court protection will increase.
LIQUIDATION
In order to establish a minimum benchmark value for Holdings, we estimated the proceeds of liquidating
it in its entirety. In doing this, we made the following assumptions:

Accounts Receivable
Holdings only holds about 6 days worth of receivables, primarily due from credit card
companies. We assume accounts receivable, net of allowance for doubtful accounts, can be
recovered in its entirety.

Merchandise Inventories
Inventories are recorded at the lesser of purchase price or market value. Given the marketability
of Holdings’ inventory, in particular that of its hardlines, we expect to recover between 40% and
60% of book value.
Page | 37

Prepaid Expenses & other current assets
Prepaid expenses and other current assets include assets held for sale ($55 million) and foreign
currency derivatives ($1 million), but we assume that very little merchandise is prepaid, and
that in a wind down scenario only 10-20% of this asset can be recovered and turned into cash.

Land
Many of Holdings’ stores have been around for many decades, and because real estate usually
appreciates in value and most properties probably have not been marked to market, we believe
it will recover at least the book value of its properties.

Buildings, furniture, fixtures & equipment, net of accumulated depreciation
We believe that the net book value of buildings can be recovered in its entirety, but predict the
recovery of other fixed assets to be relatively low. Holdings does not report the net book value
of building separately, but we estimate 30-50% of the net book value of these assets could be
recovered in liquidation.

Capital leases
Holdings currently records capital leases of $314 million. However, it has remaining capital lease
obligations of $718 million. Therefore, we assume it would be cheaper to terminate
substantially all of the leases and forfeit the properties. While it may be advantageous to pay off
some leases in order to take title to the property, we had no data to estimate to what degree
this would reduce their liability or increase assets, and therefore took the most conservative
approach and assumed the full amount of the liability would remain and that none of the
capitalized leases would be recoverable.

Tradenames and other intangibles
Holdings valuable brand assets such as Kenmore, Craftsman, and DieHard were securitized into
a bankruptcy remote special purpose entity in 2006 in order to satisfy collateral obligations for
Sears Reinsurance, a captive insurance company of Sears Holdings. At the time, the transaction
placed a value of $1.8 billion on these tradenames. We assumed that in the event of liquidation,
these brand names could be impaired, and that recovery would be 60-80%. We estimated the
recovery rate for the remainder of this asset, including Holdings’ other brands and tradenames,
to be 15-25%. Based on these assumptions, the overall recovery rate for this asset is estimated
to be between 43% and 59%.

Other Assets
We estimated the recovery rate for other assets to be 10-20%. Holding’s notes that included in
Page | 38
this asset are tax assets, which we predict will be unrecoverable, but offers little visibility into
the remaining components.

Wind Down Costs
We anticipate Holdings will incur expenses related to wind down, such as costs associated with
hiring a company to liquidate its assets, of 10%.
The above assumptions yield proceeds of $7,722 million in the worst case and $10,545 million in the
best case. Holdings currently has outstanding $1,237 million in senior secured notes. In any case,
secured creditors will be whole. Holdings also has $11,279 in unsecured debt and other liabilities, which
includes unsecured notes and unfunded pension liabilities. As the total of these liabilities exceeds the
estimated proceeds from liquidation, the fulcrum security lies somewhere in the unsecured claims, and
holders of common stock will see no returns. As Holdings is currently solvent, management’s fiduciary
duties are to shareholders, and therefore liquidation is not currently an alternative for Holdings to
pursue.
Estimated Recovery
($ millions)
Proceeds
Low
Expected
High
Low
Expected
High
747
100%
100%
100%
747
747
747
Accounts Receivable, net
695
100%
100%
100%
695
695
695
Merchandise Inventories
8,407
40%
50%
60%
3,363
4,204
5,044
388
10%
15%
20%
39
58
78
1,924
100%
100%
100%
1,924
1,924
1,924
4,339
30%
40%
50%
1,302
1,736
2,170
Capital leases
314
0%
0%
0%
0
0
0
Goodwill
841
0%
0%
0%
0
0
0
2,937
43%
51%
59%
1,263
1,498
1,733
782
10%
15%
20%
78
117
156
(941)
(1,098)
(1,255)
7,722
9,134
10,545
ASSETS
Cash & cash equivalents
Prepaid expenses & other current assets
Land
Buildings, furniture, fixtures & equipment, net
of accumulated depreciation
Tradenames & other intangibles
Other assets
Expenses associated with wind down (10%)
Total proceeds available for distribution
STRATEGIC BUYER
A question that should always be given consideration during a turnaround is whether a strategic buyer
can be sought. For our analysis, we consider whether Sears Holdings in its entirety and without being
broken apart could likely generate gains for a strategic buyer (for a breakup analysis, see the next
section).
Page | 39
There are a number of ways that a strategic buyer may find value in Sears Holdings. The usual goal is to
leverage the acquirer’s brand and management expertise to improve operations as well as its existing
infrastructure to find synergies. However, finding a domestic buyer to continue operating Holdings that
would make sense strategically will be difficult for a number of reasons. To begin with, its sheer size will
limit the number of potential buyers. It has also failed to invest in its stores for many years, and making
use of its existing facilities will likely require substantial investment. Perhaps most importantly, Holdings’
mix of store formats and locations will make it difficult for any one retailer to see a strategic fit. Most
retailers stick to either on-mall or off-mall locations depending on their target demographic and the
types of items they sell. Malls typically attract middle to up-market apparel retailers, while general
merchandise stores prefer off-mall locations. Retailers such as Dillard’s and Macy’s often have locations
in the same malls as Sears, and will thus find the retail space duplicative. Wal-Mart and Target would
also find many of Kmart’s locations duplicative, and both seem to be moving towards supercenter
formats, which Kmart’s store sizes are too small to support. Specialty stores such as Best Buy and Home
Depot may be able to find synergies given their vastly different formats, but lack experience in apparel
and others goods that Holdings retails. Finally, because Holdings’ earnings are negative, any potential
deal would not be immediately accretive to EPS. For the above stated reasons, we consider seeking a
domestic strategic buyer to continue operating Holdings in its entirety to be very unlikely.
A less typical approach is to find an acquirer that would wind down Holdings in order to remove
competition. We showed in our liquidation analysis that the best case liquidation scenario will yield
proceeds of $10.5 billion, which is still about $2 billion less than remaining liabilities. Assuming all
outstanding shares can be acquired at their current market price for a total of $6.6 billion, the cost of
winding down operations in the absolute best case is $8.6 billion. Perhaps even more problematic is the
potential for such a strategy to generate massively negative PR, as 264,000 employees would be laid off
and a 125 year old brand would disappear. Combined with the intense competition in the retail space
that will result in Holdings’ former revenues being shared among participants, we believe this strategy
to be unlikely as well.
For the forgoing reasons, we believe the most likely strategic buyer for Holdings in it’s entirely would be
an international retailer looking to enter or expand its operations in the U.S. market. Carrefour, based in
France, is the world’s second largest retailer by revenue behind Wal-Mart. It operates mostly
hypermarkets similar to Wal-Mart’s format. Metro AG, based in Germany, is the fourth largest retailer
by revenues. Metro operates a variety of store formats, but its operations have yet to cross the Atlantic.
Page | 40
Tesco, based in the UK, is the third largest retailer by revenues, generating £64.5 billion in 2011, and
second largest by profits, which totaled £3.8 billion in 2011. Tesco’s original focus was on the grocery
segment, but over the years it has diversified into general merchandise, and now operates 47
hypermarkets named “Tesco Extra”. Tesco operates in numerous countries around the world, including
the United States with its 183 “Fresh and Easy” grocery locations.
Tesco recently has experienced troubles as its efforts to boost sales in the U.K. have faltered, resulting in
the ouster of its CEO. Revenue for the UK segment grew by 5%, but profits fell by 1%. While this
development increases uncertainty, given the decline in U.K. retail sales, we believe further expanding
internationally is a viable strategy for Tesco to consider. Tesco’s US revenues grew by 27.3% from the
prior year, and net income increased by 17.7%, though it remains negative.
We believe that Tesco’s strengths in the grocery market, particularly its private label brands and
marketing philosophy, would be valuable in bolstering Kmart’s grocery segment. Other possible
synergies include sharing of transportation and distribution centers, the use of Tesco’s seemingly
superior IT infrastructure, and increased purchasing power.
Though Tesco’s recent difficulties and stated strategy may decrease the chances of a potential merger
with Holdings, we believe that, of the international retailers we examined, it would identify the most
synergies and hold the strongest potential to consider a merger with Holdings.
In order to evaluate the maximum price Tesco may be willing to pay, we created a discounted cash flow
model using the following assumptions:

Cost synergies of $350 million including those stated above, which we estimated based on
previous similar transactions, including that of Kmart and Sears, and because Tesco already
operates stores in the U.S.

Increase in gross margin of 5.5%, assuming Tesco can leverage its management expertise to
increase Holdings’ gross margin which is currently 10% below Dillard’s, 14% below Macy’s, and
9% below Home Depot’s. Tesco’s gross margin was 2.2% higher than Holdings’ in 2012.

Increase in days payable to 45 from the current 34, due to the combined entities increased size
and Tesco’s purchasing power.

Capital expenditures of $1.0 billion in the first year, $1.5 billion for the following 4 years, then
110% of depreciation in order to catch up on years of underinvestment.
Page | 41

Transaction cost of $174 million, or about 2% of the expected closing price, which includes due
diligence, legal, and investment banking fees.

Revenue increases of 7% annually for 5 years, due to overall improvement in stores as capital
expenditures increase and Tesco improves Holdings’ merchandising.
Using the above assumptions, we estimate the maximum price Tesco would pay for Holdings’ to be $8.8
billion. However, the current enterprise value of Holdings is $8.9 billion, and it would be expected that
Tesco must pay a premium of around 20% to market prices. Multiplying Holdings’ market capitalization
of $6.4 billion by 120% and adding in net debt yields a price to the seller of $10.2 billion. Because this is
far higher than the $8.8 billion of value that Tesco would receive, we do not believe such a strategic sale
is likely at current market prices. Exhibit 15 shows the discounted cash flow valuation we used to
determine these estimates.
BREAKUP ANALYSIS
Given the foregoing conclusions, if Holdings wishes to find a strategic buyer, it will have to be broken
into 2 or 3 separate companies. It is also possible that spinning off one or more of Holdings’ divisions
could unlock shareholder value. In theory, management of the conglomerate may be overburdened, and
investors may value Holdings’ securities lower because they are forced to invest in multiple industries
and companies instead of being able to target a single industry or company. As mentioned in the
overview section, operations of Sears Canada are not closely integrated with that of Sears Domestic or
Kmart, but operations of Sears Domestic and Kmart appear to be very integrated, making a potential
divestiture more costly.
Sears Canada is particularly easy to dispose of because it is currently traded on the Toronto Stock
Exchange with a current market capitalization of US $1.4 billion. While selling off its large position may
impact share price performance, it could likely realize much of this value. However, in 2010, Holdings
siphoned off surplus cash and free cash flow from Sears Canada through an extraordinarily large
dividend – CA$7.00 per share on earnings of $1.27/share, and thus it would have to be recapitalized
before it was sold. Sears Canada currently trades at a P/B ratio of .89, EV/revenue of .28, and an
EV/EBITDA of 13.6. Holdings currently trades at 1.3, .21, and 30.78 respectively. Sears Canada’s ratios
are helped by the fact that Holdings owns many of the intangible assets of the consolidated enterprise,
which should serve to increase its P/B ratio, along with most of the debt, which should serve to increase
its EV/revenue ratio. Therefore, Sears Canada’s share price may be undervalued compared to that of
Page | 42
Holdings, making it unlikely that Holdings will sell its shares on the open market. However, Holdings may
be able to sell its controlling interest to a Canadian or other buyer willing to pay a premium to the
current market price.
Valuing Kmart as a standalone entity is more difficult. Due to Holdings’ reporting practices, relative
measures are the only feasible technique of valuing Kmart. Based on available information, we selected
EV/revenue and EV/EBITDA, and averaged their results together. In selecting multiples, we looked at the
low, average, and high multiple of some of Kmart’s closest competitors, namely off-mall retailers. This
suggested an average enterprise value for Kmart of $3.7 billion (see Exhibit 10 for calculations). Our
valuation of the Sears Domestic division took a similar approach, using multiples of other department
stores, and suggested an enterprise value of $6.2 billion (Exhibit 11). Finally, as a basis for comparison,
we used similar methods to perform a relative valuation of Holdings’ in its entirety, including P/B ratios
since they are available, to get a suggested enterprise value of $12.8 billion, which, for comparison, is
above Holding’s current market capitalization of $8.6 billion (Exhibit 12).
The combined market valuation of Sears Canada and relative valuations of Kmart and Sears Domestic as
standalone entities is about $11.3 billion, below the $12.8 billion estimated for the combined entity.
While this may be affected by underperformance of Sears Canada’s stock, even a 20% increase in its
stock price will not affect the conclusion that a break up will not increase shareholder value.
Based on our analysis, we believe that the only reasons for a breakup are to generate liquidity for a
turnaround that would otherwise not be possible or if a buyer emerges willing to pay a premium to the
above values.
RECOMMENDED PLAN
While we could not hope to present an exhaustive list of restructuring options, given our analysis of
Holdings from publicly available information, we aimed to present what we believe is the most viable
option for Holdings given its current situation. With regards to Sears Canada, its present CEO, Calvin
McDonald, who has a background in Canadian Retail, presented a turnaround plan in his annual letter to
shareholders that we feel is detailed and strong. The primary tenets of the plan include:
1. “Build the core” – ensuring Sears Canada is offering the right merchandise
2. “Become customer driven and market led” – being responsive to consumer preferences and
market trends
Page | 43
3. “Get value right” – balancing cost, quality, and service
4. “Operate the best formats” – this includes a plan to renovate stores
5. “Organize the right talent” – forming the right management team to see Sears Canada through
the transformation
In addition to outlining these goals, McDonald presents tangible progress made against each one over
the last year as well as future changes that are planned. Given our limited access to Sears Canada stores
and lack of familiarity with the Canadian retail environment, we assume the division will be responsible
for its own restructuring initiatives and do not give them further treatment in our proposal.
The plan that we present for Holdings focuses on 4 areas:

Improve customer experience by revitalizing stores and improving customer service

Overhaul merchandising to better align with brand strengths and customer demand by
launching a multiple front restructuring, focusing on SKU rationalization across all segments

Unlock the value of real estate assets

Empower Sears Canada’s management to effect its own restructuring plan
INCREASE LIQUIDITY
The restructuring plan we present later in this section will require greatly increased capital expenditures.
Therefore, in order to implement the plan, Holdings will need to increase its liquidity. The primary
options at its disposal without selling or spinning off divisions are to borrow using long term debt or
unlock the value held in its real-estate investments. Sears currently holds a CCC+ debt rating, and its
borrowing rates appear to be about 6.5-7%. However, our calculations show that, on average, each
Holding’s property can be sold for about $20 million and leased back for $443 thousand per year. This
implies an interest rate of about 2.2%, and thus makes sale-leaseback agreements the preferable means
of financing Holdings turnaround. Exhibit 13 shows the calculations that were used to determine this.
We feel that sale-leaseback arrangements should be made quickly to avoid payment of premiums if the
company continues to decline in the near term.
Holdings closed 209 stores over the last 3 years, with 173 of those closings occurring in 2012. Dillard’s
and Macy’s store counts have also decreased over the last 3 years, albeit more slowly. We believe that
the saturation in the retail market will cause this trend to continue, and that Sears will find it necessary
to close an additional 50 stores in 2013. We estimate the 173 stores to be closed in 2012 will generate
Page | 44
proceeds of $1.64 billion (see Exhibit 13 for calculations). We further believe the 50 closings in 2013 will
generate an additional $480 million in proceeds.
However, we estimate the funding requirements for our proposal (excluding the purchase of Forever 21,
which will be financed with debt) to be $2.5 billion in 2012 and $1.3 billion in 2013, or about $3.8 billion
in total. In order to reach these goals, we propose entering into sale-leaseback agreement on 43 stores
in 2012 and 40 stores in 2013. After these transactions, Holdings will reduce the percentage of owned
stores from 47% to 43%
Assuming Holdings continues to roll over its existing debt, we estimate that Holdings will increase
liquidity by $3.8 billion through these transactions. Additionally, Holdings will maintain $1.8 billion in
undrawn lines of credit and access to capital markets.
CHANGES TO H ARDLINES
Sear’s currently brings in 60% of its revenues from hardlines, but we believe it has lost its
competitiveness in this segment for 3 reasons. First, specialty retailers offer a much broader and deeper
selection and appear to have more knowledgeable salespeople. Second, consumers are shopping away
from malls for these types of merchandise. Third, we believe the brands are beginning to wither from
lack of exposure and the currently poor store environment in which they are sold. Therefore, we
propose the following changes in order to meet these threats:
1. Tools, Automotive, and Lawn and Garden
Compared to specialty stores such as AutoZone and Home Depot, Sears’ and Kmart’s current
selections of tools and automotive goods are more limited, lack complimentary segments such
as lumber and plumbing supplies, and focus too heavily on the Craftsman brand. Sears does not
have the floor space or correct store format to adopt the strategy of the specialty stores.
However, it has done well with offering specialty items like garage floor coverings, high-end
garage organization, and a wide selection of tool boxes. Moreover, the Craftsman brand, and in
particular the higher end Craftsman Professional line, has a strong consumer perception that
allows it to compete with the likes of Snap-On and Mapco. We believe Holdings should leverage
this position to target the professional and “pro-sumer” market by more heavily emphasizing
the Craftsman Professional line and increasing its inventory of specialty tools, thus creating the
image that Sears has more breadth and quality in tools than its competitors. Improvements can
also be made in selection and merchandise display. Holdings has already begun selling
Page | 45
Craftsman and DieHard through other retailers, and we recommend accelerating this plan in
order to improve sales and keep the brands relevant, but only for a limited selection of tools.
2. Consumer Electronics
The electronics department in both Sears and Kmart is extremely uncompetitive, offering only a
limited selection of TVs, cameras, and a few A/V components. Though we were unable to
definitively determine the department’s performance, we strongly believe it to be below that of
appliances and tools. Holdings should consider a strategy of leasing its space to another
electronics retailer, possibly using a “store within a store” format, and collect rent and a
percentage of sales. If a suitably profitable deal cannot be struck, then we believe Holdings
should adopt a strategy in electronics that complements our proposed strategy in tools – focus
on the high end and harder to find items. Product displays should be renovated to match the
higher end merchandise, and sales staff training should be greatly increased.
3. Appliances
Sears’ appliance selection continues to be competitive and accounts for 16% of its revenues. We
believe Holdings should maintain the exclusivity of the Kenmore brand to continue attracting
shoppers and offer and advertise a larger appliance selection in its Kmart stores. The lighting
and floor space in the appliance department lacked excitement and interest, and therefore
could be improved upon. We also felt that appliances could be more heavily advertised in other
department throughout the store, possibly with the use of large banner ads and limited time
promotions.
4. Sporting Goods
Sears’ and Kmart’s sporting goods selection focuses on home fitness equipment, which we
believe is quite competitive but under-marketed. Sears is actually America’s largest fitness
retailer, yet many individuals we spoke with were only vaguely aware of the department’s
presence. We feel there are a number of opportunities to cross market with men’s and women’s
apparel, and Sears should additionally consider advertisements targeted at active individuals,
such as charity marathons and bike races. The department should also be staffed with
knowledgeable sales people that can advise consumers on their purchases, and, as with other
departments, product display and arrangement can be improved.
APPAREL
Apparel and soft home currently account for 25% of Sears’ revenue but, at least in the stores we visited,
over 60% of its floor space. Kmart appears to be a little more balanced, with 31% of its revenue coming
Page | 46
from apparel and soft home and a similar percentage of floor space dedicated to the category. While
Sears and Kmart could choose to diminish the segment and utilize the floor space for the currently more
profitable hardlines, we believe apparel is well aligned with the on-mall format and that it presents
opportunities for Sears to create unique competitive advantages over other mall retailers.
Men’s Apparel
Sears’ hardlines, and in particular its tools, are particularly popular among male shoppers. Though about
17% of men’s clothing purchases are made by someone else (often their wives)5, we believe it should
leverage this popularity to cross sell men’s apparel, for instance by grouping the departments close
together and advertising promotions for apparel in tools and vice versa. In stores we visited, despite
having what appeared to be high quality and maturely styled men’s apparel for rock bottom prices,
there was no mention of the promotions in the tools section. The industry has seen growth in men’s
apparel in recent years, and we believe this unique combination will differentiate it from competitors.
Women’s and Juniors’ Apparel
From our observations of Sears and Kmart stores, we believe the women’s and juniors’ apparel sections
are in much worse conditions than the men’s. Styles appeared outdated, department layout was poor,
and the aesthetics of the environment lagged significantly behind Sears’ competitors. For these reasons,
we believe Sears will have difficulty even regaining parity with its competition without external
expertise. As mentioned in the Industry Trends section, fast fashion is a growing trend in the apparel
industry, and we believe Sears and Kmart should offer their own fast fashion brand to reinvigorate sales.
Because fast fashion requires specialized design and manufacturing techniques, we propose that
Holdings seek to acquire an existing fast fashion retailer in order to gain their expertise, and combine
the fast fashion retailer’s strengths in apparel design with its own strengths in sourcing casual apparel to
revamp its higher end offerings targeted at older age demographics. Fast fashion is markedly different
than classic apparel retailing. Instead of relying on a few in house designers, fast fashion retailers source
designs from hundreds of designers and place orders for small quantities of each design. The best selling
products are then reordered. One way to apply this to larger and longer lead time orders may be to
reward the design contracts to the best performing designers. Hopefully, as younger customers mature,
they can be transitions to the higher end apparel lines.
5
“A Quarter of Male Shoppers Lack Fashion Sense, Reports Mintel”, PRN Newswire. March 19 2012.
Page | 47
We believe such a merger would be advantageous to the target as well, because it will be able to grow
its brand faster through Sears’ and Kmart’s existing locations and benefit from cost synergies, particular
in the areas of advertising, logistics, and infrastructure.
We believe Forever 21 would provide the best strategic fit for Holdings. Forever 21 is private, but
according to Forbes.com, its revenue increased by 18.2% in 2011 to $2.6 billion. It employs 27,000
employees across 480 stores averaging 9,000 sq. ft. in size, has operating income of $319 million, profits
of $124 million, and total assets of $1.4 billion. This implies a revenue per sq. ft. of about $600. Forever
21 has also signed agreements to lease space within some of Sears’ stores, and is experimenting with
larger format stores. Because Forever 21 has locations in many of the same malls as Sears, we propose
that it maintain separate locations until the expiration of their leases (or when economically
advantageous), and then move into renovated Sears stores using a store-within-a-store format in order
to drive foot traffic to Sears.
Given the limited information available, we attempted to value Forever 21 based on revenue multiples
that we estimated from 3 of its closest publicly traded competitors: Inditex (parent company of Zara),
H&M, Benetton Group S.p.a, traded on the Madrid Stock Exchange, the Helsinki Exchange, and the
Borsa Italiana respectively. This yielded a valuation of $1.2 billion. We assumed a purchase premium of
20%, yielding a cost of $1.44 billion. Exhibit 14 shows the calculations that were used to obtain this. In
our model, we assume that Sears would acquire Forever 21 mostly in cash, and that the transaction
would close in June 2013. We chose to use debt to finance this transaction for two reasons. First, we
wanted to limit the number of sale-leaseback agreements because it already owns a smaller percentage
of its stores than many of its competitors. Second, if synergies do not emerge and it chooses to divest
Forever 21, it will not be able to package the sale-leasebacks with Forever 21 as they are against
Holdings’ existing properties, and the premium to revert ownership to Holdings will probably be high.
In addition to the improvements in the styling of its apparel, Holdings must renovate the floor space to
increase the perceived quality of its clothing and accessories. This would include using more elegant
shelving, elevating certain products on walls and medians to expose them to the customer, and
installing lighting to match the sophistication of their merchandise. Holdings should also reduce the
percentage of SKUs advertising sales – the sea of red tags impairs the image of quality and broad
selection. In order to incent sales of full price items, Holdings should consider promotions that offer
discounts on other items purchased in the same transaction, which, if successful, should increase the
Page | 48
average sale total. One example of this would be offering a discount on an item of men’s apparel when
an item of women’s apparel is purchased at full price.
RENOVATE STORES
We believe that one of the biggest problems facing Holdings is the deteriorating conditions of its stores
and poor store layout. Holdings should seek an outside architectural firm with proven experience in
designing modern retail spaces to develop a consistent trade dress6 that is unique to Sears and Kmart
and aligns with their core values of quality and service. In addition to installing better lighting, shelving,
and product displays, the design should position merchandise to maximize sales, and be adaptable to
the store-within-a-store concept as Forever 21 locations migrate into Sears’ floor space and possibly into
Kmart locations. We estimate the cost of renovation per store to be $3.5 million7, or $6.1 billion for all
1949 remaining stores.
IMPROVE CUSTOMER SERVICE
Based on our observations in Sears and Kmart stores, we believe that customer service needs to be
dramatically improved to compete with Best Buy, Home Depot, and other department stores. Much of
this will be a cultural transformation, but Holdings can also invest in employee training and reduce
turnover by offering better benefits. Holdings may also consider revising the pay and commission
structure to better incent sales staff. Holdings has about 97 employees per owned store, and after the
store count is reduced in 2012 and 2013, we estimate that 222,000 employees will remain. We also
noticed that many of Holdings’ competitors offer price check stations throughout the store, allowing
customers to scan merchandise to see the current price. This is particularly useful given Holdings’
excessive discounts on apparel, and would free up sales staff to provide higher value services.
IMPROVE MARGINS
As mentioned in the profitability section, Holdings’ gross margin is below that of many of its
competitors. We believe this is in large part due to discounts Holdings must offer to incent sales. While
hardlines seem appropriately priced, apparel is steeply discounted. We believe that by changing the
style of their apparel offerings and other measures to improve sales, gross margins will improve.
However, SG&A expense seems far too high. $1.9 billion of its $10.7 billion SG&A expense is related to
advertising, second only to Wal-Mart’s budget of $2.0 billion, despite bringing in $447 billion, and thus
we believe Holdings should focus its advertising dollars better. Holdings’ head count per store is less
6
7
A form of intellectual property encompassing the characteristics of the visual appearance of a product, packaging, or even a building.
Estimate based on publicly reported cost of renovating a similarly sized Kroger store.
Page | 49
than half that of the industry average, and therefore we do not recommend reducing headcount any
further. However, we believe Holdings should begin a diligent search for other ways to reduce costs.
MANAGEMENT
As mentioned in the Management section, leadership of Holdings has seen high turnover and has not
publicly announced plans to address the company’s core problems. Our recommendations are to
increase non-CEO executive compensation to match that of the industry and increase the collective
retail experience among top leadership. We expect this to increase SG&A expense by $8 million.
VALUATION OF THE PLAN
In order to see the effects and test the viability of our proposal, we created a discounted cash flow
model which integrated the effects of our assumptions on the overall business of Holdings. The
following explains the assumptions that were used in this process.
A SSUMPTIONS
Revenue
In order to calculate the effects on revenue of our proposed turnaround, we divided Holdings’ total
revenue into segments, subtracted revenue lost due to store closures, and factored in what we estimate
the growth for each segment to be. Most importantly, we believe that hardlines will increase by 3% and
4% in 2013 and 2014 respectively and 3% thereafter, as tools and batteries are sold through other
retailers. We believe that Men’s apparel is extremely depressed, and that through our proposed
changes, revenue from this segment will increase by 7% and 10% in 2013 and 2014 respectively, and 34% thereafter. We estimate women’s apparel will increase by 10% and 15% in 2014 and 2015
respectively, and 3-4% thereafter. Because the proposed merger with Forever 21 will give the fast
fashion retailer a larger base of stores, we estimate revenue will increase at a rate of 22% from 2013 to
2015 (compared with 18% in 2011). Finally, we believe Sears Canada’s turnaround plan will increase
revenues by 1.5% in 2013 and slowly ramp up to 3% growth by 2016. Exhibit 15 provides further details
of our estimates.
Gross Margin
We do not have any reason to believe that the prices Holdings pays for its merchandise will decrease,
however, we believe gross margin will steadily improve from 25.5% to 32% as the store renovations
attract shoppers instead of steeply discounted prices. However, this is partially offset by increased costs
of occupancy related to the sale-leaseback agreements.
Page | 50
SG&A Expense
We assume that SG&A expense as a percent of revenue will at first increase to 28% as Holdings is unable
to scale back overhead in proportion to store closings. Further, we expect the expense of the plan
outlined in the Customer Service section will serve to increase SG&A by $444 million. As revenue grows
and advertising and other costs become more efficient, we expect SG&A to gradually decrease to 21%,
still higher than many of its competitors.
Non-operating Expense
We expect the store closings discussed in the liquidity section to generate non-operating expenses of
$299 million in 2012 and $155 million in 2013 (see Exhibit 13). Additionally, we expect other
restructuring charges to total $100 million in 2012 and $50 million in 2013, based on prior years’ charges
relative to the number of store closings.
Working Capital
Working capital should slightly decrease as conditions improve and Holdings is able to secure better
terms from its vendors. However, in order to be conservative, we assume working capital needs will stay
consistent on a percentage of revenue basis with current values.
Long Term Assets
We expect to realize a reduction in net Property & Equipment of $1,240 and $640 million in 2012 and
2013 respectively in connection with the store closings and sale-leaseback agreements. Exhibit 13
provides details of how this was calculated.
Capital Expenditures
We estimate that capital expenditures will total $1.0 billion in 2013, $1.5 billion in both 2014 and 2015,
and $1.75 billion thereafter. These expenditures will mostly be related to the renovation of stores.
Debt
We assume that long-term debt will increase by $1.44 billion in 2013, and that debt will be rolled over
until 2017, when it will start being paid off.
Shares Outstanding
Assuming the Forever 21 acquisition is made with cash, this transaction will have no impact on shares
outstanding. For the purposes of our model, we assume outstanding shares will remain unchanged.
Page | 51
WACC
We computed Holdings’ weighted average cost of capital for each forecast year by using CAPM and
adjusting it for the additional risk associated with Holdings’ size (1%) and the uncertainty in the forecast
period (5%). For the terminal value year, we reduced the uncertainty premium to 4%. The beta was
estimated using an industry average asset beta that was relevered based on Holdings’ capital structure
for each forecast year. Due to the effect of a falling beta but increasing risk free rates, the WACC varies
from 11.8% in 2013 to 15.5% in 2016.
R ESULTS
Using the above assumptions, we projected Holdings’ net present value to be $11.5 billion, representing
a 14% increase in value over the current combined enterprise values of Holdings and Forever 21. We
also performed a sensitivity analysis with an upside and downside case. For the upside case, we
increased revenues by 2% from the base case and gross margin by 1%. This increased Holdings’ present
value to $14.7 billion. For the downside case, we decreased revenue and gross margin by 2% from the
base case. This had the effect of reducing net present value to $7.3 billion, 27% lower than the current
combined enterprise values of Holdings and Forever 21, and required increasing liquidity by about $2
billion through more sale-leaseback agreements. Exhibits 16 through 27 show our assumptions,
projected income statements, balance sheets, cash flows, discounted cash flow valuation, and EPS
estimates.
Exhibit 22 shows our projected cash flows. The sale-leaseback agreements and store closings will
generate $2.5 billion in cash in 2013 and $1.3 billion in 2014, divided equally between disposal of fixed
assets and gains from sale of assets (our calculations in Exhibit 13 show the market value of stores to be
twice the book value). The gain on sales of assets has the effect of increasing cash flow from operations,
though it remains negative. Cash flow from investing includes the disposal of fixed assets, the purchase
of Forever 21, and a decrease in other long term assets due to shrinking operations, calculated as a
percentage of sales. Lastly, the issuance of $1.44 billion in debt in 2013 to fund the purchase of Forever
21 causes cash flow from financing to be an equal amount.
Exhibit 27 shows our projected earnings per share. The store closings and poor margins cause EPS to be
negative in 2013, but slightly recover in 2014 as the effects of the purchase of Forever 21 and improving
margins take effect. EPS continues to climb until reaching $18 per share in 2017.
Page | 52
Based on the above calculations and foregoing strategic alternatives, we believe the proposed
restructuring plan has the highest potential to increase shareholder value and ensure Holdings’
continued survival.
Page | 53
APPENDIX
EXHIBIT 1. HISTORICAL FINANCIAL STATEMENTS
STATEMENT OF INCOME
Year ended January 28, 2012
Year ended January 29, 2011
Year ended January 30, 2010
(US$ millions)
Total
Total
Total
Sears
Kmart Canada
Sears
Kmart Canada
Sears
01/31/2009 02/02/2008
Kmart Canada
Total
Total
Revenue
Merchandise sales & services
41,567
21,649
15,285
4,633
42,664
22,275
15,593
4,769
43,360
22,989
15,743
4,628
46,770
50,703
Cost of sales, buying & occupancy
30,966
15,849
11,818
3,299
31,000
15,910
11,757
3,333
31,374
16,203
12,038
3,133
34,118
36,638
Selling & administrative expenses
10,664
6,042
3,371
1,251
10,425
5,940
3,341
1,144
10,499
6,065
3,386
1,048
11,060
11,468
Depreciation & amortization
853
601
149
103
900
620
149
100
926
640
152
102
981
1,049
Impairment charges
649
634
15
64
(30)
(34)
(1,447)
(34)
Expenses
Gain on sales of assets
Operating Income
Interest Expense
(1,501)
(289)
(20)
-
67
(46)
(7)
14
437
(149)
353
233
(293)
74
(6)
(23)
45
667
87
190
390
41
36
33
Other loss, net
(2)
(14)
(61)
Income tax expense
Net Income
Adjusted EBITDA
-
51
38
(248)
Interest and Investment Income
Income from continuing operations before taxes
360
(1,751)
186
420
184
1,452
(1,369)
(36)
(123)
(85)
(550)
(3,140)
150
297
53
826
1,385
1,744
1,524
2,459
277
Page | 54
BALANCE SHEET
(US$ millions)
2011
2010
2009
2008
2007
747
1,375
1,689
1,173
1,622
7
15
11
124
-
Accounts receivable, net
695
683
652
839
744
Merchandise inventories
8,407
9,123
8,705
8,795
9,963
388
312
351
458
438
ASSETS
Current assets
Cash & cash equivalents
Restricted cash
Prepaid expenses & other current assets
Deferred income taxes
-
27
30
27
35
10,244
11,535
11,438
11,416
12,802
Land
1,924
2,055
2,059
2,056
2,084
Building and improvements
6,186
6,343
6,193
6,040
6,165
Furniture, fixtures and equipment
2,786
2,918
2,766
2,518
2,774
314
399
374
345
334
Gross property and equipment
11,210
11,715
11,392
10,959
11,357
Less accumulated depreciation
4,633
4,350
3,683
2,868
2,494
Total property and equipment, net
6,577
7,365
7,709
8,091
8,863
841
1,392
1,392
1,392
1,686
2,937
3,139
3,208
3,283
3,353
Other assets
782
837
1,061
1,160
693
Total assets
21,381
24,268
24,808
25,342
27,397
1,175
360
325
442
162
230
509
482
345
242
Merchandise payables
2,912
3,101
3,335
3,006
3,487
Other current liabilities
2,892
3,115
3,098
3,226
3,971
Unearned revenues
964
976
1,012
1,069
1,121
Other taxes
523
557
534
424
525
Short-term deferred tax liabilities
516
-
-
-
-
Total current liabilities
9,212
8,618
8,786
8,512
9,562
Long-term debt and capitalized lease obligations
2,088
2,663
1,698
2,132
2,606
Pension and postretirement benefits
2,738
2,151
2,271
2,057
1,258
Other long-term liabilities
2,186
2,222
2,618
1,227
1,244
15,654
15,373
15,962
16,730
Total current assets
Property and Equipment
Capital leases
Goodwill
Trade names and other intangible assets
LIABILITIES
Current Liabilities
Short-term borrowings
Current portion of long-term debt and capitalized lease obligations
Long-term deferred tax liabilities
Total Liabilities
816
17,040
EQUITY
Common stock
1
1
1
1
1
Treasury stock, at cost
(5,981)
(5,826)
(5,446)
(5,012)
(4,331)
Capital in excess of par value
10,005
10,185
10,465
10,441
10,419
Retained earnings (accumulated depreciation)
1,865
4,930
4,797
4,562
4,509
Pension & postretirement adjustments, net of tax
(1,575)
(783)
(686)
(489)
115
(5)
1
9
3
3
Currency translation adjustments
(29)
3
(44)
(126)
(49)
Noncontrolling interest
60
103
339
4,341
8,614
9,435
9,380
10,667
Cumulative unrealized derivative gain
Total equity (deficit)
Page | 55
CONSOLIDATED STATEMENT OF CASH FLOWS
($ millions)
2011
2010
2009
2008
2007
-3,147
150
297
53
826
2,020
-386
-283
-41
-41
CASH FLOWS FROM OPERATIONS ACTIVITIES
Net Income (loss)
Adjustments to reconcile income to cash
Depreciation and Amortization
853
900
926
981
1,049
Changes in Working Capital
-33
-534
567
-1
-287
Other Operating Cash Flow
32
-275
130
1,507
992
1,547
-360
-406
-338
-411
-475
51
0
166
-226
38
-309
-406
-172
-637
-437
Change in ST Debt
815
35
-117
280
68
Change in LT Debt
-507
966
-335
-245
-669
Change in Equity
-226
-997
-411
-678
-2,926
Cahs Flow from Operations
CASH FLOWS FROM INVESTING ACTIVITIES
Net Purchase of PP&E
Other Investing Cash Flows
Cash Flow from Investing
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of Dividends
Other Financing Cash Flows
-69
-110
-30
-88
0
88
-28
-95
-951
-643
-3439
Opening Cash
1,359
1,689
1,173
1,622
3,839
Change in Cash
-612
-371
384
-288
-2,329
747
1375
1689
1173
1622
Cash Flow from Financing
RECONCILIATION TO CASH
Closing Cash
Page | 56
EXHIBIT 2. KEY EXECUTIVES
Edward S. Lampert, Chairman of the Board
Mr. Lampert is the Chief Executive Officer of ESL Investments, a privately owned hedge fund which he
founded in 1988. The fund’s investing style, similar to that of Warren Buffet’s, is contrarian and
“concentrated value”, meaning that it tends to hold large stakes for many years in a small number of
companies, many of them in the retail space. For 4 years prior to founding his own fund, Mr. Lampert
worked at Goldman Sachs as an intern and later in the firm’s risk arbitrage division. From July 1999 to
October 2006, Mr. Lampert served as Director and Chairman of the Compensation Committee for
AutoZone. When Kmart filed for bankruptcy in 2002, ESL Investments purchased a significant amount of
Kmart debt, and when it emerged from bankruptcy in 2003, ESL Investments owned 53% of the new
entity. In 2005, Kmart purchased Sears to form the current Sears Holdings. As of February 2012, Mr.
Lampert owns about 62% of Sears Holdings. Mr. Lampert also holds stakes in Autonation, AutoZone, Big
Lots, Gap, and Orchard Supply.
Louis J. D'Ambrosio, President and Chief Executive Officer
Mr. D’Ambrosio became Holdings’ Chief Executive Officer in February 2011 after having served as a
consultant to the board for 6 months prior. The preponderance of Mr. D’Ambrosio experience has been
in Information Technology and Telecommunications. Mr. D’Ambrosio spent 16 years at IBM serving in
various leadership positions to eventually oversee worldwide sales and marketing for its $12 billion
software group. After leaving IBM, he joined Avaya in 2003, a Fortune 500 computer networking, IT, and
telecommunications company, as a Senior Vice President of Global Services. He became President and
Chief Executive Officer in July 2006, at which time Avaya was a publicly traded company with $5.1 billion
in revenue and approximately 18,500. During his tenure lasting until June 2008, he successfully led the
company through an $8.3 billion buyout by TPG Capital and Silver Lake Partners that took the company
private and delivered a substantial return to shareholders.
Ronald D. Boire, Chief Merchandising Officer and President of Sears and Kmart Formats
Mr. Boire became Chief Merchandising Officer for Holdings in January 2012 to lead merchandising for
both Sears and Kmart format stores. Mr. Boire holds a long career in merchandising. Prior to joining
Holdings, Mr. Boire was Chief Executive Officer of Brookstone, a private chain of retail stores with about
300 locations. Previously, Mr. Boire served as President of North America for Toy’s “R” Us where he
oversaw all merchandising, marketing, and operations for Toys “R” Us almost 600 stores. From June
2003 until June 2006, Mr. Boire was Executive Vice President and Global Merchandise Manager for Best
Page | 57
Buy where he oversaw purchasing for many of Best Buy’s products including consumer electronics,
software computer, and appliances. Mr. Boire worked at Sony Electronics for 17 years, eventually
becoming President of Sony Electronics Consumer Sales. During his tenure at Sony, he worked on
shifting their focus to Gen-Y consumers and the successful branding of XPLOD® car stereos and the relaunch of the Walkman® brand.
W. Bruce Johnson, Executive Vice President Off-Mall Businesses and Supply Chain
Mr. Johnson has been in his current position since February 2011. Mr. Johnson joined Kmart in 2003 as
Senior Vice President, Supply Chain and Operations, after the merger with Sears, he assumed the same
responsibilities for the combined entity. Mr. Johnson also served as Holdings’ interim President and
Chief Executive Officer for 3 years prior to Mr. D’Ambrosio. Prior to joining Kmart, Mr. Johnson worked
at Colgate-Plamolive and Carrefour.
Robert A. Schriesheim, CFO
Mr. Schriesheim became Chief Financial Officer of Holdings in August, 2011. Previously Mr. Schriesheim
has over 17 years of experience holding executive level positions at Aon Hewitt, ADF, Lawson Software,
Global Telesystems, Ameritech, ACNielson, SBC Equity partners, and numerous others.
Dane A. Drobny, General Counsel
Mr. Drobny has served as Senior Vice President, Corporate Secretary and General Counsel for Holdings
since May 2010.
William R. Harker, Senior Vice President
Mr. Harker has been in his position since May 2010. Mr. Harker has served in various executive level
positions with sears since September 2005, including Senior Vice President, Human Resources and
General Counsel from December 2006 to May 2010.
William K. Phelan, Senior Vice President, Finance
Mr. Phelan has been in his current position since August 2011. Mr. Phelan was elected Senior Vice
President and Controller in September 2007, having previously served as Vice President and Controller
from 2005 to 2007, Treasurer from December 2007 until December 2008, and Acting Chief Financial
Officer from May 2011 to August 2011.
Robert A. Riecker, Vice President, Controller and Chief Accounting Officer
Mr. Riecker joined Holdings as Assistant Controller in 2005, served as Vice President and Assistant
Page | 58
Controller from May 2007 until October 2011, and elected Vice President, Controller and Chief
Accounting Officer in January 2012. He has also served as Vice President, Internal Audit.
EXHIBIT 3. EXECUTIVE COMPENSATION
Sears
JC Penny1
Macy's
Wal-mart
Target
Dillard's
CEO Compensation
9.9
53.3
17.7
18.1
15.0
11.8
Other Sec. 14A Compensation, avg.
1.8
27.4
4.6
8.2
6.0
7.9
41,750
17,260
26,405
446,950
68,466
6,263
277
264
516
154
2,450
171
34,658
2,200
6,832
365
726
39
($ millions)
Revenue (ttm)
EBITDA
Number of Employees (thousands)
(1) Number of employees as of 2010
EXHIBIT 4. RELATIVE MEASURES OF EXECUTIVE COMPENSATION
Compensation over
Revenue
EBITDA
Employees
Sears
0.023791
0.035859
0.037625
Competitors
0.020492
0.002564
0.039553
Sears
0.004255
0.006413
0.006729
Competitors
0.009577
0.001198
0.018485
CEO
Other Sec. 14A
Page | 59
EXHIBIT 5. COMPARISON OF REVENUE WITH SELECTED COMPETITORS
2011
($millions)
2010
Revenue % Change
2009
Revenue % Change
2008
Revenue % Change
2007
Revenue % Change
Revenue
Sears
Sears Domestic
21,649
-2.8%
22,275
-3.1%
22,989
-9.2%
25,315
-9.1%
27,845
Kmart
15,285
-2.0%
15,593
-1.0%
15,743
-2.9%
16,219
-6.0%
17,256
4,633
-2.9%
4,769
3.0%
4,628
-11.6%
5,236
-6.5%
5,602
Sears Canada
41,567
-2.6%
42,664
-1.6%
43,360
-7.3%
46,770
-7.8%
50,703
Dillard's
6,263
2.3%
6,120
0.4%
6,094
-10.8%
6,830
-5.2%
7,207
Target
68,466
4.1%
65,786
3.7%
63,435
0.9%
62,884
2.3%
61,471
Wal-mart
443,854
5.9%
418,952
3.4%
405,046
0.9%
401,244
7.1%
374,526
JC Penny
17,260
-2.8%
17,759
1.2%
17,556
-5.0%
18,486
-6.9%
19,860
Macy's
26,405
5.6%
25,003
6.4%
23,489
-5.6%
24,892
-5.4%
26,313
Best Buy
50,705
1.9%
49,747
0.1%
49,694
10.4%
45,015
25.3%
35,934
Home Depot
70,395
3.5%
67,997
2.8%
66,176
-7.2%
71,288
-7.8%
77,349
Total
Total Retail
Square Feet
(millions)
Revenue per
Square Foot
($thousands)
Employees
(thousands)
Sears Domestic
128.9
168.0
N/A
Kmart
124.6
122.7
N/A
Revenue per
Employee
($thousands)
Sears
Sears Canada
19.6
236.4
N/A
273.1
152.2
264
157.5
52.7
118.8
39
160.6
Target
233.6
293.1
365
187.6
Wal-mart
626.7
708.2
2,200
201.8
JC Penny
111.2
155.2
154
112.1
Macy's
151.9
173.8
171
154.4
43.7
1160.3
180
281.7
209.1
336.7
331
212.7
Total
Dillard's
Best Buy
Home Depot
Page | 60
Sears Domestic
Kmart
1%
31%
37%
15%
0%
25%
60%
31%
Overall
Sears Canada
8%
5%
14%
49%
51%
44%
29%
Hardlines
Apparel and Soft Home
12%
Food and Drug
Service and Other
24%
16%
48%
Hardlines
Apparel and Soft Home
Drugs and Cosmetics
Service and Other
Page | 61
EXHIBIT 6. CHANGE IN REVENUE FROM 2010 TO 2011
($ millions)
Sears Domestic
2011 Revenue
2010 Revenue
% of Total
Change
Same Store Sales
21,560
22,198
51.9%
-2.9%
-3.4%
1
Sears Canada
Kmart
Online2
4,633
4,769
11.1%
-2.9%
-7.7%
15,285
15,593
36.8%
-2.0%
-1.4%
89
77
0.2%
16.0%
16.0%
Overall
-2.20%
1
Adjusted to exclude online
2
Estimated
EXHIBIT 7. HISTORICAL PROFITABILITY RATIOS FOR HOLDINGS
2011
($ millions)
2010
Amount
%
Amount
2009
%
Amount
%
Amount
%
%
SG&A
10,664
25.7%
10,571
24.4%
10,654
24.2%
11,060
23.6%
11,468
22.6%
Gross Margin
10,601
25.5%
11,878
27.4%
12,219
27.7%
12,652
27.1%
14,065
27.7%
64
0.2%
67
0.2%
74
0.2%
51
0.1%
38
0.1%
-3,140
-7.6%
133
0.3%
235
0.5%
53
0.1%
826
1.6%
277
0.7%
1,385
3.2%
1,744
4.0%
1,524
3.3%
2,459
4.8%
Adjusted EBITDA
46,770
Amount
41,567
Net Income
44,043
2007
Revenue
Operating Income
43,326
2008
50,703
ROA
-13.8%
0.5%
0.9%
0.2%
2.9%
ROE
-49.2%
1.5%
2.6%
0.5%
7.1%
EXHIBIT 8. COMPARISON OF PROFITABILITY WITH SELECTED COMPETITORS
Sears
Dillard's
Target
Wal-mart
JC Penny
Macy's
Best Buy Home Depot
Revenue
41,567 6,263,600
69,865
446,950
17,260
26,405
50,272
70,395
COGS
30,966 4,041,550
48,306
335,127
11,042
15,738
37,635
46,133
SG&A
10,664 1,679,017
14,106
85,265
5,109
8,281
10,325
16,028
64
464,773
5,322
26,558
-2
2,386
2,114
6,661
Net Income
-3,140
463,909
2,929
15,699
-152
1,256
1,277
3,883
Gross Margin Rate
25.5%
35.5%
30.9%
25.0%
36.0%
40.4%
25.1%
34.5%
SG&A % of Sales
25.7%
26.8%
20.2%
19.1%
29.6%
31.4%
20.5%
22.8%
0.2%
7.4%
7.6%
5.9%
0.0%
9.0%
4.2%
9.5%
-7.6%
7.4%
4.2%
3.5%
-0.9%
4.8%
2.5%
5.5%
ROA
-13.8%
10.7%
6.5%
8.4%
-1.3%
5.9%
7.1%
9.7%
ROE
-49.2%
22.5%
18.8%
22.5%
-3.2%
22.0%
19.8%
21.2%
Operating Income
Operating Income % of Sales
Net Income % of Sales
Page | 62
EXHIBIT 9. COMPARISON OF CAPITAL EXPENDITURES TO DEPRECIATION FOR SELECTED
COMPETITORS
2011
2010
2009
2008
2007
2006
2005
Total
853
900
926
981
1,049
1,142
932
6,783
Sears
Depreciation
Capital Expenditures
432
441
361
497
570
513
546
3,360
-49.4%
-51.0%
-61.0%
-49.3%
-45.7%
-55.1%
-41.4%
-50.5%
Depreciation
259,467
263,395
264,763
286,184
300,859
303,256
304,376
1,982,300
Capital Expenditures
115,651
98,184
75,089
189,579
396,337
320,640
456,078
1,651,558
-55.4%
-62.7%
-71.6%
-33.8%
31.7%
5.7%
49.8%
-16.7%
2,131
2,084
2,023
1,826
1,659
1,496
1,409
12,628
Investment
Dillard's
Investment
Target
Depreciation
Capital Expenditures
4,368
2,129
1,729
3,547
4,369
3,928
3,388
23,458
105.0%
2.2%
-14.5%
94.2%
163.4%
162.6%
140.5%
85.8%
8,130
7,641
7,157
6,739
6,317
5,459
4,717
95,058
Capital Expenditures
13,510
12,699
12,184
11,499
14,937
15,666
14,563
46,160
Investment
66.2%
66.2%
70.2%
70.6%
136.5%
187.0%
208.7%
-51.4%
518
511
495
469
426
389
372
3,180
Investment
Wal-Mart
Depreciation
JC Penny
Depreciation
Capital Expenditures
Investment
634
499
600
969
1,243
772
535
5,252
22.4%
-2.3%
21.2%
106.6%
191.8%
98.5%
43.8%
65.2%
1,070
1,125
1,187
1,251
1,273
1,216
95
7,217
Macy's
Depreciation
Capital Expenditures
Investment
555
339
355
761
994
1,317
568
4,889
-48.1%
-69.9%
-70.1%
-39.2%
-21.9%
8.3%
497.9%
-32.3%
978
926
793
580
509
456
459
4,701
Best Buy
Depreciation
Capital Expenditures
Investment
744
615
1,303
797
733
648
502
5,342
-23.9%
-33.6%
64.3%
37.4%
44.0%
42.1%
9.4%
13.6%
1,682
1,718
1,806
1,902
1,906
1,886
1,579
12,479
Home Depot
Depreciation
Capital Expenditures
Investment
Competitor Average
1,221
1,096
966
1,847
3,558
3,542
3,881
16,111
-27.4%
-36.2%
-46.5%
-2.9%
86.7%
87.8%
145.8%
29.1%
13.3%
Page | 63
EXHIBIT 10. RELATIVE VALUATION OF KMART AS A STANDALONE ENTITY
(US$ millions)
Driver (2 yr. avg.)
Low
Base
High
Suggested Avg. EV
EV/revenue
15,439
0.17
0.25
0.60
5249
EV/EBITDA
340
4
7.07
7.5
2105
Average value
3677
EXHIBIT 11. RELATIVE VALUATION OF SEARS DOMESTIC AS A STANDALONE ENTITY
(US$ millions)
Driver (2 yr. avg.)
Low
Base
High
Suggested Avg. EV
EV/revenue
21,962
0.20
0.50
0.70
10249
EV/EBITDA
281
5
7
10
2061
Average value
6155
EXHIBIT 12. RELATIVE VALUATION OF SEARS CANADA AS A STANDALONE ENTITY
(US$ millions)
Driver (2 yr. avg.)
Low
Base
High
Suggested Avg. EV
Price/book
6478
1.2
2.4
4
16411
EV/revenue
42,116
0.20
0.50
0.70
19654
EV/EBITDA
831
5
7
10
6094
Average value
12874
EXHIBIT 13. CALCULATIONS AND ASSUMPTIONS USED IN RESTRUCTURING PLAN
Based on results from the closing of 247 stores in 2011, Holdings records a store closing cost of about
$1.1 million per Kmart store and $1.4 million per Sears domestic store. On average, each store requires
about $450 thousand in working capital. Based on recently reported transactions and information
available in public filings, we estimate that the average fair market value and carrying value for a store
which Holding’s owns to be $20 million and $10 million, respectively. In 2011, Sears operating leases
costs totaled $837 for 1,890 stores, or about $443 thousand per store. Holdings currently owns 47.1% of
its domestic and full-line stores. We calculate that the average life left on a lease is 52 months, but due
to the preference for closing stores whose lease will soon expire, we use 24 in our calculations. We
expect that through negotiating with lessors and sub-leasing, Holdings will only incur half the remaining
contractual obligation when it closes a leased store. We estimate that the average store generates
about $16 million in revenue each year, but we assume that the lower performing stores bring in only
$12.5 million. Based on the above, we estimate that closing each store nets $9.5 million in cash and
reduces revenue by $12.5 million.
Page | 64
($US millions)
FY2012
FY2013
Owned
82
24
Leased
92
26
Stores Closed
174
50
Effect on gross value of land
Total
(492)
(144)
Effect on gross value of other long term assets
(696)
(200)
Effect on accumulated depreciation
(348)
(100)
Charges related to closings
299
86
Sale of long term assets
820
240
Gain on sale of assets
820
240
In 2011, Holdings reporting having 264,000 full and part time employees and 2711 stores (including
Sears Canada and specialty stores). This equates to about 97 employees per store. After the closing of
224 stores, we expect Holdings to have about 242,000 employees.
EXHIBIT 14. VALUATION OF FOREVER 21
EV/revenue
Zara
H&M
Benetton
Average
0.64
0.10
0.8795602
0.54
(US$ millions)
Driver
Low
Base
High Suggested Avg. EV
EV/revenue
2,400
0.20
0.54
0.80
1232
Page | 65
EXHIBIT 15. VALUATION OF HOLDINGS TO TESCO
DISCOUNTED CASH FLOW VALUATION
(US$ millions)
Projected
EBIT
TV Year
1/28/2013
1/28/2014
1/28/2015
1/28/2016
1/28/2017
1/28/2018
2,781
2,288
1,518
1,560
1,615
1,828
Tax rate
40%
40%
40%
40%
40%
40%
EBI
1669
1373
911
936
969
1097
651
943
1083
1223
1363
1901
Depreciation & amortization
Change in net working capital
-56
4
-105
-113
-121
-74
-1000
-1500
-1500
-1500
-1500
-1996
Free Cash Flow to Firm
1264
820
389
546
711
927
Cost of short-term debt
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Cost of debt
4.2%
4.2%
4.2%
4.2%
4.2%
7.0%
Cost of equity
13.5%
13.5%
13.5%
13.8%
14.0%
14.5%
WACC
10.1%
10.6%
10.8%
11.2%
12.0%
13.4%
Terminal Value
0
0
0
0
0
9836.4
Periodic Value
1264.2
819.6
388.6
546.5
10547.9
0.0
Discounted value
8749.3
8371.0
8436.7
8958.4
9417.2
0.0
Present value of firm
8,749
Capital expenditures
Page | 66
EXHIBIT 16. VALUATION OF PROPOSED RESTRUCTURING PLAN
Model Assumptions
Basic Company Information
Valuation Assumptions
Ticker
SHLD
Forecast Period Asset Beta
Last Closing Price
57.94
Market Risk Premium
52 Week High
85.9
Terminal Value Assumptions
52 Week Low
28.89
Terminal Value Beta
Last FY End Date
1/28/2012
Net PP&E to sales in Terminal Value
Current FY End Date
1/28/2013
Capex % of Depreciation for Terminal Value
Periodicity
Annual
Working capital % of revenue
Months Projected
60
Debt Ratio
Precision
0.0001
Cost of Debt
7.0%
Units
US$ millions
Terminal Growth Rate
3.0%
Cash and Short Term Debt Assumptions
1.41
5.75%
1.41
2.0%
105.0%
5.0%
30.0%
Model Validation
Rate
Spread
Balance sheet balances
Passed
Surplus funds interest rate
1M Libor
0.125
No unpaid principal
Passed
Cash & equivalents interest rate
1M Libor
0.125
No unpaid debt interest
Passed
Short-term debt rate
1M Libor
2.05%
Short-term borrowing limit breached
Passed
10000
Cashflows reconcile starting / endind cash
Passed
Short-term debt limit
EXHIBIT 17. CAPITAL EXPENDITURES OF PROPOSED RESTRUCTURING PLAN
CAPITAL EXPENDITURES
(US$ millions)
Name
Depreciation Method
Capex 1
Amount
Date Recorded
Useful Life
Salvage Value
Straight Line
1000
6/28/2013
10
100
Capex 2
Straight Line
1500
1/28/2014
10
100
Capex 3
Straight Line
1500
1/28/2015
10
100
Capex 4
Straight Line
1750
1/28/2016
10
100
Capex 5
Straight Line
1750
1/28/2017
10
100
EXHIBIT 18. LONG TERM DEBT OF PROPOSED RESTRUCTURING PLAN
LONG TERM DEBT
(US$ millions)
Debt Instrument
Base Rate
Spread Term (months)
Balance
Issue Date
Maturity Date
Payment Type
Priority
Pro Rata Seq
Existing Debt
Bond Rate
0.00%
120
3263
1/28/2012
1/28/2022
Level
Sequential
1
Rollover 1
Bond Rate
0.00%
60
1766
1/28/2013
1/28/2023
Level
Sequential
2
Rollover 2
Bond Rate
0.00%
60
679.5
1/28/2014
1/28/2024
Level
Sequential
3
Rollover 3
Bond Rate
0.00%
60
815
1/28/2015
1/28/2025
Level
Sequential
4
Rollover 4
Bond Rate
0.00%
60
978
1/28/2016
1/28/2026
Level
Sequential
5
Page | 67
EXHIBIT 19. REVENUE ASSUMPTIONS OF PROPOSED RESTRUCTURING PLAN
REVENUE ASSUMPTIONS
FY2012
FY2013
FY2014
FY2015
FY2016
FY2017
Sears Domestic & Kmart
Prior Year Revenue
36,934
34,625
36,844
39,567
42,184
44,043
Store closings
174
50
0
0
0
0
Reduction in revenue per store
12.5
12.5
12.5
12.5
12.5
12.5
(2,175)
(625)
0
0
0
0
16,683
15,639
15,808
16,440
16,934
17,442
0.0%
3.0%
4.0%
3.0%
3.0%
3.0%
0
469
632
493
508
523
3,156
2,569
2,426
2,498
2,673
2,941
0.0%
1.0%
3.0%
7.0%
10.0%
3.0%
0
26
73
175
267
88
4,782
4,195
4,110
4,521
5,199
5,407
0.0%
2.0%
10.0%
15.0%
4.0%
3.0%
0
84
411
678
208
162
2,400
16.0%
384
2,784
3,396
4,144
5,055
5,561
22.0%
22.0%
22.0%
10.0%
4.0%
612
747
912
506
222
11,769
11,613
11,729
11,964
12,323
12,692
0.0%
1.0%
2.0%
3.0%
3.0%
3.0%
0
116
235
359
370
381
4,633
4,633
4,702
4,797
4,916
5,064
0.0%
1.5%
2.0%
2.5%
3.0%
3.0%
Effect of store closings on revenue
Hardlines
Prior year revenue
% increase (decrease) in category sales
Change in overall revenue
Men's apparal (est. 33% of apparel sales)
Prior year revenue
% increase (decrease) in category sales
Change in overall revenue
Women's apparal (excluding fast fashion, est
50% of apparel sales)
Prior year revenue
% increase (decrease) in category sales
Change in overall revenue
Fast fashion apparel (integrated 2H 2013)
Prior year revenue
% increase (decrease) in category sales
Change in overall revenue
Other
Prior year revenue
% increase (decrease) in category sales
Change in overall revenue
Sears Canada
Prior Year Revenue
% increase (decrease) in category sales
Change in overall revenue
Total Revenue
% Change from prior year
0
69
94
120
147
152
37,867
38,739
41,454
43,749
45,958
47,444
-8.9%
2.3%
7.0%
5.5%
5.0%
3.2%
Page | 68
EXHIBIT 20. PRO FORM STATEMENT OF INCOME FOR PROPOSED RESTRUCTURING PLAN
PRO FORMA STATEMENT OF INCOME
(US$ millions)
Actual
Projected
TV Year
1/28/2012
1/28/2013
1/28/2014
1/28/2015
1/28/2016
1/28/2017
1/28/2018
Revenue
41,567
37,867
38,739
41,454
43,749
45,958
47,444
COGS
30,966
27,825
28,054
29,564
30,698
31,700
32,136
Gross Profit
10,601
10,042
10,685
11,891
13,051
14,258
15,308
SG&A Expense
10,664
10,603
10,072
9,534
9,625
9,651
9,963
-
-
-
-
-
-
-
1,240
640
-
-
-
-
(63)
680
1,252
2,356
3,426
4,607
5,345
Depreciation & amortization
853
651
853
993
1,133
1,298
1,200
EBIT
(916)
28
399
1,363
2,293
3,309
4,145
(499)
(198)
-
-
-
-
201
191
170
177
180
301
91
88
92
98
103
107
292
279
261
275
283
408
-
-
-
-
-
-
Operating Expenses
Gain on sale of assets
EBITDA
Non-operating Expenses
Interest Income
From surplus funds
From cash & equivalents
Total Interest Income
-
Interest Expense
Short-term debt
Existing Debt
228
206
183
160
137
114
Rollover 1
-
124
99
74
49
25
Rollover 2
-
-
48
38
29
19
Rollover 3
-
-
-
57
46
34
Rollover 4
Total interest expense
EBT
Taxes
Net Income
Dividends
Net to reatined earnings
(accumulated deficit)
-
-
-
-
68
44
-
228
329
329
329
329
236
(916)
(407)
151
1,296
2,239
3,263
4,318
-
-
60
518
895
1,305
1,727
(916)
(407)
91
777
1,343
1,958
2,591
-
-
-
-
-
-
-
(916)
(407)
91
777
1,343
1,958
2,591
Page | 69
EXHIBIT 21. PRO FORM BALANCE SHEET FOR PROPOSED RESTRUCTURING PLAN
PRO FORMA BALANCE SHEET
(US$ millions)
Actual
Projected
1/28/2012
TV Year
1/28/2013
1/28/2014
1/28/2015
1/28/2016
1/28/2017
1/28/2018
1,576
1,421
1,243
1,537
1,294
3,436
681
696
745
786
826
853
ASSETS
Current assets
Surplus funds
Cash & cash equivalents
Accounts receivable, net
Inventory
754
695
633
648
693
731
768
793
8,407
7,659
7,835
8,384
8,848
9,295
9,596
Inventory Purchased
Prepaid expenses & other current assets
Total current assets
27,077
28,231
30,113
31,162
32,146
32,437
388
353
362
387
408
429
443
10,244
10,902
10,962
11,452
12,312
12,612
15,120
1,924
1,186
694
694
694
694
694
Property and Equipment
Land
9,286
9,286
10,786
12,286
14,036
15,786
15,786
Gross property and equipment
Other fixed assets
11,210
10,472
11,480
12,980
14,730
16,480
16,480
Less accumulated depreciation
4,633
5,284
6,137
7,130
8,263
9,561
10,761
Total property and equipment, net
6,577
5,188
5,343
5,850
6,467
6,919
5,719
Other long term assets
4,560
5,594
5,690
5,988
6,239
6,482
6,645
21,381
21,684
21,994
23,289
25,018
26,013
27,484
2,912
2,612
2,723
2,905
3,006
3,101
3,129
-
-
-
-
-
-
-
Total assets
LIABILITES
Current Liabilities
Accounts Payable
Short-term debt
5,125
4,696
4,804
5,140
5,425
5,699
5,883
Total current liabilities
Other current liabilities
8,037
7,307
7,527
8,045
8,431
8,799
9,012
Long-term debt
3,263
4,703
4,703
4,702
4,702
3,370
2,039
Other long-term liabilities
Total Liabilities
5,740
5,740
5,740
5,740
5,740
5,740
5,740
17,040
17,750
17,969
18,487
18,873
17,910
16,790
60
60
60
60
60
60
60
2,416
2,416
2,416
2,416
2,416
2,416
2,416
1,865
1,458
1,549
2,326
3,669
5,627
8,217
EQUITY
Noncontrolling interest
Total common equity
Retained earnings (accumulated deficit)
Total shareholder equity (deficit)
Total liabilities and shareholder equity
Total shares outstanding (mil)
4,341
3,934
4,025
4,802
6,145
8,103
10,693
21,381
21,684
21,994
23,289
25,018
26,013
27,484
106
106
106
106
106
106
106
1,903
2,101
2,058
2,516
2,626
4,767
-
-
-
-
-
-
Model Balancing
Surplus cash
Required short-term debt
Page | 70
EXHIBIT 22. PRO FORMA STATEMENT OF CASH FLOWS
PRO FORMA STATEMENT OF CASH FLOWS
(US$ millions)
Actual
1/28/2012
Projected
TV Year
1/28/2013 1/28/2014 1/28/2015 1/28/2016 1/28/2017 1/28/2018
Cash flows from operations
Net income (loss)
(407)
91
777
1,343
1,958
2,591
Non-cash expenses
(499)
(198)
-
-
-
-
Depreciation & amortization
651
853
993
1,133
1,298
1,200
Cahnge in net working capital
115
20
(102)
(138)
(135)
(127)
(140)
766
1,669
2,338
3,120
3,663
1,240
640
-
-
-
-
(1,500)
(1,750)
(1,750)
-
Cash flow from operations
Cash flows from investing
Disposal of fixed assets
Capital expenditures
Sale of long-term investments
(1,500)
-
-
-
-
-
-
(1,034)
(96)
(298)
(252)
(242)
(163)
206
(956)
(1,798)
(2,002)
(1,992)
(163)
-
-
-
-
-
-
Increase in long-term debt
1,440
-
-
-
-
-
Decrease in long-term debt
-
-
(0)
(0)
(1,332)
(1,332)
Increase in common stock
-
-
-
-
-
-
Decrease in common stock
-
-
-
-
-
-
Cash flow from financing
1,440
-
(0)
(0)
(1,332)
(1,332)
Net change in cash
1,506
(189)
(130)
336
(204)
2,168
754
2,257
2,117
1,988
2,324
2,120
2,257
2,117
1,988
2,324
2,120
4,288
Purchase of long-term investments
Cash flow from investing
Cash flows from financing
Dividends paid
Opening cash
Closing cash
Page | 71
EXHIBIT 23. CHANGES IN WORKING CAPITAL FOR PROPOSED RESTRUCTURING PLAN
WORKING CAPITAL
(US$ millions)
Projected
1/28/2013
Decrease (increase) in accounts receivable
Decrease (increase) in inventory
Decrease (increase) in other current assets
Increase (decrease) in accounts payable
Increase (decrease) in short-term debt
Increase (decrease) in other current liabilities
Change in net working captial
1/28/2014
TV Year
1/28/2015
1/28/2016
1/28/2017
1/28/2018
62
-15
-45
-38
-37
-25
748
-176
-549
-464
-447
-301
35
-8
-25
-21
-21
-14
-300
111
182
101
95
28
0
0
0
0
0
0
-429
108
337
285
274
184
115
20
-102
-138
-135
-127
EXHIBIT 24. DISCOUNTED CASH FLOW VALUATION FOR PROPOSED RESTRUCTURING PLAN
DISCOUNTED CASH FLOW VALUATION
(US$ millions)
Projected
1/28/2013
EBIT
TV Year
1/28/2014
1/28/2015
1/28/2016
1/28/2017
1/28/2018
28
399
1,363
2,293
3,309
4,145
40%
40%
40%
40%
40%
40%
17
240
818
1376
1985
2487
Depreciation & amortization
651
853
993
1133
1298
1764
Change in net working capital
115
20
-102
-138
-135
-74
0
-1500
-1500
-1750
-1750
-1853
Free Cash Flow to Firm
783
-387
209
621
1398
2325
Cost of short-term debt
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Cost of debt
4.2%
4.2%
4.2%
4.2%
4.2%
7.0%
Relevered Beta
2.06
2.06
2.06
2.06
1.87
1.69
6%
6%
6%
6%
6%
5%
Cost of equity
20.8%
20.8%
20.8%
21.1%
20.3%
17.1%
WACC
11.8%
11.9%
12.6%
16.0%
15.5%
15.5%
Tax rate
EBI
Capital expenditures
Additional Risk Premium
Terminal Value
0
0
0
0
0
18613.5
Periodic Value
783.2
-387.0
209.3
620.8
20011.4
0.0
Discounted value
11523.8
12097.1
13919.4
15463.7
17318.6
0.0
Present value of firm
11,524
Page | 72
EXHIBIT 25. DISCOUNTED CASH FLOW VALUATION IN UPSIDE CASE
DISCOUNTED CASH FLOW VALUATION
(US$ millions)
Projected
1/28/2013
TV Year
1/28/2014
1/28/2015
1/28/2016
1/28/2017
1/28/2018
EBIT
403
829
1,948
3,046
4,286
5,338
Tax rate
40%
40%
40%
40%
40%
40%
EBI
242
497
1169
1827
2572
3203
Depreciation & amortization
651
853
993
1133
1298
1982
Change in net working capital
66
-10
-137
-180
-183
-133
0
-1500
-1500
-1750
-1750
-2081
Free Cash Flow to Firm
959
-160
525
1031
1936
2971
Cost of short-term debt
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Cost of debt
4.2%
4.2%
4.2%
4.2%
4.2%
7.0%
Relevered Beta
2.06
2.06
2.06
2.06
1.87
1.69
6%
6%
6%
6%
6%
5%
Cost of equity
20.8%
20.8%
20.8%
21.1%
20.3%
17.1%
WACC
12.2%
12.5%
13.4%
16.0%
16.3%
15.8%
Capital expenditures
Additional Risk Premium
Terminal Value
0
0
0
0
0
23198.1
Periodic Value
959.1
-159.9
524.6
1030.8
25134.5
0.0
Discounted value
14727.2
15559.9
17665.9
19513.3
21606.5
0.0
Present value of firm
14,727
Page | 73
EXHIBIT 26. DISCOUNTED CASH FLOW VALUATION IN DOWNSIDE CASE
DISCOUNTED CASH FLOW VALUATION
(US$ millions)
Projected
1/28/2013
1/28/2014
EBIT
-590
Tax rate
40%
EBI
TV Year
1/28/2015
1/28/2016
1/28/2017
1/28/2018
-209
444
1,222
2,042
2,704
40%
40%
40%
40%
40%
-354
-125
266
733
1225
1623
Depreciation & amortization
651
853
993
1133
1298
1567
Change in net working capital
198
49
-68
-100
-94
-26
0
-1500
-1500
-1750
-1750
-1645
Free Cash Flow to Firm
495
-723
-308
16
680
1519
Cost of short-term debt
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Cost of debt
4.2%
4.2%
4.2%
4.2%
4.2%
7.0%
Relevered Beta
1.86
1.86
1.86
1.87
1.80
1.72
6%
6%
6%
6%
6%
5%
Cost of equity
19.7%
19.7%
19.7%
20.0%
19.9%
17.1%
WACC
11.9%
11.4%
11.7%
15.3%
14.0%
14.5%
Capital expenditures
Additional Risk Premium
Terminal Value
0
0
0
0
0
13223.9
Periodic Value
495.2
-723.2
-308.5
15.9
13903.4
0.0
Discounted value
7251.1
7622.0
9213.2
10595.0
12196.5
0.0
Present value of firm
7,251
EXHIBIT 27. ESTIMATED EARNINGS PER SHARE IN BASE CASE
EARNINGS PER SHARE
(US$ millions, except per share amounts)
Projected
TV Year
1/28/2013
1/28/2014
1/28/2015
1/28/2016
1/28/2017
1/28/2018
Net Income
(407)
91
777
1,343
1,958
2,591
Shares outstanding (mil)
106.8
106.8
106.8
106.8
106.8
106.8
EPS
(3.81)
0.85
7.28
12.58
18.33
24.26
Page | 74
Disclosures
The author of this report holds no financial interest in any of the companies mentioned in this report, nor
is the author aware of conflict of interest that could bias the content of this report. The author does not
serve as an officer, director, advisor, or employee of any company mentioned in this report. All
information contained herein has been obtained or derived from readily available public sources deemed
by the author to be reliable, but the author makes no representation or warranty, express or implied, as to
its accuracy and completeness. This report was written by a student participating in the Carl Marks
Student Paper Competition for educational purposes only, and should not be used as the basis of any
investment decision. This information does not constitute investment advice, nor is it an offer or
solicitation of an offer to buy or sell any security.
Page | 75